New Monetary Policy Tools: What Have We Learned?
In a speech at the Central Bank of Guatemala, Federal Reserve Bank of Boston President Eric Rosengren discussed "new" monetary policy tools (including forward guidance and large-scale asset purchases) and shared his opinion on how U.S. monetary policy could evolve.
"My own view is that the ‘new' monetary tools were essential," Rosengren said. He said that large-scale asset purchases, forward guidance, and the Fed's program to purchase longer-term securities (maturity extension), contributed to lower marketplace interest rates, "a faster improvement in labor markets than forecasters were expecting," and rebounding asset prices. All this at a time when the U.S. economy was in the throes of a significant recession and a painfully slow recovery-with the federal funds rate hitting the zero lower bound.
As the Federal Reserve considers its exit from a very accommodative policy stance, significant attention is being given to potential financial stability matters. "I personally do not expect that it will be appropriate to raise short-term rates until the U.S. economy is within one year of both achieving full employment and returning to within a narrow band around 2 percent inflation," said Rosengren. "However, both the transition to higher rates and the operating procedure for doing so could entail financial stability effects that should be thoughtfully considered-and I am certain will be."
Rosengren offered a few potential exit-strategy options, including the possibility of a gradual and transparent reduction in the Fed's balance sheet, when that becomes appropriate. One possibility would be reinvesting "all but a percentage of securities on the balance sheet as they reach maturity," and gradually increasing that percentage.
Turning to raising rates, when appropriate, one tool would be raising the rate of interest that the Federal Reserve pays on excess reserves. Or, the Federal Reserve could engage in overnight reverse repurchase agreements, which are, in effect, collateralized loans to the Fed that would provide a risk-free rate of return to investors. The Fed "could in effect place a floor on how low short-term rates would fall in the marketplace" since investors would be unwilling to accept lower rates of return.
"Regardless of the tools eventually chosen, history shows that monetary policy ‘exits' can be unsettled," said Rosengren. "Effective and transparent communication has become even more important." Still, he called it important to avoid binding specificity about future actions, since policies should be responsive to actual conditions.
"While the new policies have been instrumental in achieving better economic outcomes, clearly they are not without challenges," Rosengren noted. But "we need to seize this opportunity to carefully consider a broader set of monetary policy tools-and how those tools impact financial stability in addition to inflation and unemployment."