Federal Reserve Monetary Policy Since the Financial Crisis Hitotsubashi-IMF Seminar 23 January 2014 Ellen E. Meade Senior Adviser Division of Monetary Affairs Federal Reserve Board
Overview 1. Central bank mandate and progress toward objectives 2. Nontraditional monetary policy 3. Flow-based asset purchase program 4. Recent developments 5. The road ahead 1 P age
Federal Reserve s Mandate The goals of monetary policy spelled out in the Federal Reserve Act Board of Governors and the Federal Open Market Committee (FOMC) "to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates" 2 P age
Progress toward Objectives 3 P age
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Points to Note Does GDP growth understate progress? o GDP vs. GDI Divergence between labor market and goods market Different signals from the labor market o Unemployment rate vs. labor force participation rate Softness in inflation o Oil prices o Administered prices for medical care o Imputed banking services 7 P age
Nontraditional Monetary Policy 8 P age
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Policy at the Zero Lower Bound (ZLB) Approach to providing additional accommodation since late 2008 Asset purchase programs (LSAPs) Depress term premiums and put downward pressure on longer-term rates Ease financial conditions more broadly Signal commitment to accommodative policy stance Uncharted waters Forward guidance about path of policy Shapes expectations regarding future short-term rates Reduces uncertainty regarding interest rates Feasibility of commitment over long horizons 10 P age
Asset Purchase Programs LSAP #1 Announced November 2008, increased March 2009, completed March 2010 Total $1.25 trillion agency MBS, $175 billion agency debt securities, $300 billion Treasury securities Reduced yield on 10-year Treasury securities 40 to 110 basis points LSAP #2 Announced November 2010, completed June 2011 Total $600 billion Treasury securities Reduced yield on 10-year Treasury securities 15 to 45 basis points 11 P age
Asset Purchase Programs (continued) Maturity Extension Program Announced September 2011, extended June 2012, completed December 2012 Buy 6-30 years, sell 1-3 years; did not increase balance sheet Total nearly $700 billion Treasury securities Total effect of 2 LSAPs + MEP = 80 to 120 basis points Flow-based purchase program $40 billion agency MBS per month since September 2012 $45 billion Treasury securities per month since December 2012 Taper to $35 billion agency MBS, $40 billion Treasuries starting January 2014 12 P age
Federal Reserve Balance Sheet Flow-based purchases from September 2012 through January 2014 total more than $1.2 trillion Reinvestment policy Maturing Treasury securities rolled over at auction Maturing agency debt and MBS securities reinvested in agency MBS Asset purchases have expanded reserve balances held at Federal Reserve Banks from $870 billion in August 2007 to $2.5 trillion 13 P age
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Forward Guidance Defines the period over which rates will remain low Unspecified length o exceptionally low levels of the federal funds rate for some time (December 2008) o for an extended period (March 2009) Calendar dates o at least through mid-2013 (August 2011) o at least through late-2014 (January 2012) o at least through mid-2015 (September 2012) Thresholds provide economic conditionality (December 2012) o exceptionally low range for the federal funds rate will be appropriate at least as long as the unemployment rate remains above 6-1/2 percent, inflation between one and two years ahead is projected to be no more than a half percentage point above the Committee s 2 percent longer-run goal and inflation expectations well anchored 15 P age
Forward Guidance (continued) Describes what happens after crossing threshold consider other information, including additional measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial developments (December 2012) based on assessment of these factors... it likely will be appropriate to maintain the current target range for the federal funds rate well past the time that the unemployment rate declines below 6½ percent, especially if projected inflation continues to run below the Committee's 2 percent longerrun goal (December 2013) Describes the path after funds rate liftoff Take a balanced approach 16 P age
December 2013 Summary of Economic Projections 17 P age
Effects of Forward Guidance Pushed back the anticipated date of the onset of tightening Flattened the expected pace of tightening once it is underway Reduced uncertainty about the path of future policy Helped to keep market expectations reasonably aligned with those of the Committee and pushed back against expectations that the Committee would begin raising the federal funds rate prematurely 18 P age
Adoption of for some time in mid-december 2008 Consensus of professional forecasters (from the Blue Chip Financial Indicators) regarding the quarterly average value of the federal funds rate at forecast horizons from 0 to 6 quarters ahead as of December 1, 2008 (dashed line) and February 1, 2009 (solid line), from Unconventional Monetary Policy and Central Bank Communications, speech by Janet Yellen at the U.S. Monetary Policy Forum, February 25, 2011 19 P age
Computed from rates on overnight interest rate swaps, assuming a monthly term premium of zero 20 P age
Implied volatility of short-term rates has fallen to low levels 21 P age
Flow-based Asset Purchase Program 22 P age
Conditions for Ending Program With earlier programs, total quantity of asset purchases and time frame for program completion was announced when program commenced Flow-based program different Stopping conditions state-contingent and depend on economic outcomes FOMC indicated it was looking for substantial improvement in the outlook for the labor market in a context of price stability Would take appropriate account of likely efficacy and costs of purchases 23 P age
Efficacy and Costs Efficacy = Benefits Downward pressure on longer-term rates Foster stronger economic recovery Provide signal about policy intentions Guard against downside risks to economy Possible that effects diminish as purchases grow Potential Costs Impair market functioning Implications for financial stability and inflation expectations Complications for exit from unconventional policy Federal Reserve income and remittances to Treasury 24 P age
Recent Developments 25 P age
Spring/Summer 2013 Nominal yield on 10-year Treasury below 1.7 percent in late April Between April 30/May 1 FOMC and June 18-19 meeting, tightening of financial conditions Chairman s JEC testimony in May 10-year Treasury rose 53 basis points over intermeeting period Expected path of federal funds rate shifted in At press conference following June meeting, Chairman sought to provide clarity Improvement in economy since start of flow-based purchase program Policy is data dependent purchases vary with economic conditions If conditions evolve as expected, reduce pace of purchases later in 2013 o End around mid-2014 when unemployment rate about 7 percent Forward guidance thresholds for the funds rate are not triggers Distinction between tapering of asset purchases and liftoff of funds rate 26 P age
Market Reaction Longer-term yields continued to rise after the June FOMC meeting Between June and July meetings, 10-year Treasury yield up 44 basis points and another 23 basis points between July and September meetings Financial market movements often difficult to account for, even ex post Improvements in the economic outlook Reported unwinding of levered positions together with liquidations of other positions in response to investor losses and rise in volatility o May have reduced future risks to financial stability o May have lowered probability of sharper market correction later on Market participants may have seen June communication as indicating lessening of commitment to highly accommodative stance of policy o Appeared that forward guidance for the federal funds rate became less effective after June o Markets did not view two nontraditional policy tools as distinct 27 P age
No Taper in September FOMC applied the framework announced at the June meeting and decided not to begin the taper Outlook similar to June but not sufficient confirmation to warrant taper Labor market conditions still far from what all of us would like to see Meaningful progress made since program began Purchases not on a preset course Restrictive fiscal policy and debate over debt ceiling Concerns about tightening of financial conditions both long-term and shortterm yields Tightening over intermeeting period was not welcome or warranted 28 P age
Median funds rate in 2016 = 2 percent, below longer-run equilibrium value of 4 percent Gradual increase after liftoff, more gradual than in previous episodes of tightening Headwinds to economic recovery 29 P age
Market Reaction Investors had priced in significant odds that the FOMC would reduce the pace of purchases at the September meeting Interest rates moved lower following the decision to maintain the current pace of purchases o 10-year Treasury moved down 15+ basis points on announcement o Dropped 33 basis points over intermeeting period leading up to October FOMC meeting Decision in September led to some criticism that the Federal Reserve had not communicated well in advance o Current environment is very complex o A number of FOMC participants noted that decision was a close call 30 P age
December Tapering Positive tone of incoming data and strong November employment report Cumulative progress in labor market since September 2012 along with substantial improvement in labor market outlook o Unemployment rate fallen from 8.1 percent to 7 percent in November Taper of $5 billion each in Treasury and MBS purchases o Purchasing $75 per month from January 2014 o Still adding to accommodation but at a slower pace o Committee will likely reduce the pace of asset purchases in further measured steps at future meetings o purchases not on preset course but are dependent on data Qualitative forward guidance for post-threshold period o Appropriate to maintain range for funds rate well past the time threshold is crossed, especially if inflation below 2 percent 31 P age
The Road Ahead 32 P age
December FOMC statement pointed to further measured steps at future meetings o If taper $10 billion per meeting program ends in 2014:Q4 o Could be adjusted up or down as necessary depending upon economy SEP gives indication of time between crossing unemployment threshold and liftoff of federal funds rate as well as gradual tightening after liftoff Exit strategy principles discussed in minutes of June 2011 FOMC meeting Broad principles remain applicable Cease reinvestments and allow maturing securities to roll off balance sheet Use reserve draining operations to reduce the size of reserve balances o Term deposits, term and overnight reverse repos Large majority of participants expect no sales of agency mortgage-backed securities during the process of normalizing monetary policy 33 P age
Thank you 34 P age