Commodity supply shocks and a Fed-induced tightening of financial conditions threaten an incredibly promising domestic business cycle expansion and an otherwise fragile global economy. Balance of payments crises are spreading due to weighty import bills. An appreciating dollar and increased costs of financial intermediation are likely to prolong the effects of these shocks or destroy local supply-side responses. The Fed’s commitment to the price stability side is intended to cool the demand side of the economy but will likely entail some collateral consequences on the supply side. Accordingly, the Department of Treasury should be making use of the Exchange Stabilization Fund (ESF) to target accelerated supply-side responses and insure critical producers against downside risks.

In the absence of a serious ESF response to address the root causes of inflation, unilateral reliance on the Fed to effectively offset supply shocks will increase the risk of a global recession. The Fed’s ability to impact inflation and employment derives from its ability to tighten financial conditions and lower asset prices. But without an assist, the Fed’s tightening will reduce employment and stifle investment at a time when the global economy needs investment in non-discretionary commodities more than ever. The Fed’s tightening can have demand-side effects on inflation, but it will likely come with supply-side effects including limiting capital expenditures, increasing intermediation costs, and weaker inventory replenishment. At a time when supply-side responsiveness is most critical, the Exchange Stabilization Fund is ideally suited to mitigate these collateral consequences.

Secretary Yellen should announce the establishment of a Supply Insurance and Acceleration Program (SIAP) using the Exchange Stabilization Fund. This program could help reduce fears of commodity-linked exchange rate crises, and demonstrate to market participants and private actors that localized supply and investment deficiencies will be filled. With a mix of tools at its discretion, including the sale of put options (price insurance) and loan guarantee fees, the Exchange Stabilization Fund can overcome virtually any private hurdle rate (the rate of return that firms require in order to justify investing in a given project) while providing much-needed certainty in this historically uncertain time.

## This is the Moment for the ESF

The ESF is uniquely matched to today’s complex of historic risks. It provides (1) broad authority; (2) a highly discretionary and versatile toolkit; and (3) enough capital to deploy that the action will have a considerable impact on the markets in question.

### Authority

The ESF provides broad authority to act in moments like these. The key paragraph establishing the bounds of action states the following:

Consistent with the obligations of the Government in the International Monetary Fund on orderly exchange arrangements and a stable system of exchange rates, the Secretary or an agency designated by the Secretary, with the approval of the President, may deal in gold, foreign exchange, and other instruments of credit and securities the Secretary considers necessary. However, a loan or credit to a foreign entity or government of a foreign country may be made for more than 6 months in any 12-month period only if the President gives Congress a written statement that unique or emergency circumstances require the loan or credit be for more than 6 months.”

Though the scope of Treasury’s authority has never been litigated, a textual analysis evinces a strong argument that Congress intended to give the Secretary of Treasury wide latitude to determine when and how to use the fund (for a deeper analysis, please see our companion research report: Discretion is the Point: The Misunderstood Legal Bounds of the ESF).

The economic case for the use of this authority today is clear. The ESF has been utilized in similar moments in the past, most notably in 2008 and at the onset of the COVID-19 pandemic in 2020 (and prior to passage of the CARES Act). Multiple commodity shocks are threatening the stability of the international exchange rate system, stoking disastrous balance of payments crises across emerging markets alongside widespread recession. The costs of price-inelastic necessities like oil and food are skyrocketing, and new production requires time we don’t have and investments that private actors are rationally holding back on due to a range of uncertainties.

## Conclusion

On September 16, 2008, “as the money market fund complex unraveled,” a small group of Treasury and Federal Reserve officials gathered to craft a solution. Just three days later, before most of the details had been sorted out or even discussed, Secretary Paulson announced the creation of a guarantee program for money market funds. Ten days later, the program was up and running. It took just two weeks for money market funds to stabilize (they even began to grow).

We are at a similar inflection point today. The confluence of several economic challenges, from painful inflation, to balance of payments crises in emerging markets, to tighter financing conditions, can all be directly linked to the surging prices of major commodities. Now is the time to spur as much investment and production as possible. Secretary Yellen should announce a Supply Insurance and Acceleration Program.

What we’re suggesting is not a cure-all for every economic problem. Commodity production is complex, and there is no way to increase production by simply turning a single dial. Investment takes time to come to fruition, and can be hindered by other challenges like appropriate weather or inputs (food production is hindered by the fertilizer shortages, which are in turn exacerbated by shortages in potash and natural gas). It will not be easy, but like most economic crises, we should heed the call of President Roosevelt, and engage in bold, persistent experimentation.