The Federal Open Market Committee’s minutes, released on Tuesday, provide some insight into the thinking behind the central bank’s December decision to lower the target rate to 0 to 1/4 per cent and its decision to move beyond traditional monetary stimulus.
Some highlights, beginning with how close we came to not getting a target at all:
Members debated how best to communicate their decisions regarding monetary policy actions. Since the large amount of excess reserves in the system would limit the Federal Reserve’s control over the federal funds rate, several members thought that it might be preferable not to set a specific target for the federal funds rate. Indeed, those members felt that lack of an explicit target could be helpful, in that it would focus attention on the shift in the policy framework from targeting the federal funds rate to the use of balance sheet policies and communications about monetary policy as a way of providing further monetary stimulus.
A few members stressed that the absence of an explicit federal funds rate target would give banks added flexibility in pricing loans and deposits in the current environment of unusually low interest rates. However, other members noted that not announcing a target might confuse market participants and lead investors to believe that the Federal Reserve was unable to control the federal funds rate when it could, in fact, still influence the effective federal funds rate through adjustments of the interest rate on excess reserves and the primary credit rate. The members decided that it would be preferable for the Committee to communicate explicitly that it wanted federal funds to trade at very low rates; accordingly, the Committee decided to announce a target range for the federal funds rate of 0 to ¼ percent.
This was funny to us for a few reasons. Notably because the Fed has all but explicitly conceded that its ability to control the effective fed funds rate has been shattered. Even with the effective rate dipping below zero per cent and a deluge of liquidity operations, banks aren’t lending (the kernel of Richard Bove’s “problem” yesterday). That’s why we’ve seen the shift to quantitative easing in the first place — if you can’t get banks to lend out their excess reserves, you use them instead. No surprise then there was some talk in the meeting of setting a specific quantitative target — like Japan earlier this decade:
Participants discussed the potential advantages and disadvantages of setting quantitative targets for bank reserves or the monetary base. Some were of the view that quantitative targets for an increasing reserve base could be effective in preventing deflationary dynamics and useful in communicating to the public the Committee’s determination to take the steps needed to avoid such an outcome.
Several other participants, however, noted that increases in excess reserves or the monetary base, by themselves, might not have a significant stimulative effect on the economy or prices because the normal bank intermediation mechanism appeared to be impaired, and banks may not be willing to lend their excess reserves. Conversely, a decline in excess reserves or the monetary base would not necessarily be contractionary if it occurred in the context of improving financial market conditions.
A few of those who supported quantitative base or reserve targets did so because they saw them as helping to coordinate the actions of the Board of Governors, which is responsible for authorizing most special liquidity and lending facilities, and the Committee, which is responsible for open market operations. Most participants, however, were of the view that such coordination would best be achieved by continued close cooperation and consultation between the Committee and the Board. Going forward, consideration will be given to whether various quantitative measures would be useful in calibrating and communicating the stance of monetary policy.
Conversely (promisingly) there was also some rumblings of starting to define an exit strategy from QE:
Participants emphasized that the ultimate objective of special lending facilities and asset purchases was to support overall market functioning, financial intermediation, and economic growth. Participants acknowledged that the effective federal funds rate probably would need to remain very low for some time. However, they also recognized that, as economic activity recovered and financial conditions normalized, the use of certain policy tools would need to be scaled back, the size of the balance sheet and level of excess reserves would need to be reduced, and the Committee’s policy framework would return to focus on the level of the federal funds rate.
No word on how that “scaling back” might be acheived though.
Another item discussed was the potential for setting some sort of inflation target to help calm investors about a deflationary spiral:
Another possible form of communication that participants discussed was a more explicit indication of their views on what longer run rate of inflation would best promote their goals of maximum employment and price stability. The added clarity in that regard might help forestall the development of expectations that inflation would decline below desired levels, and hence keep real interest rates low and support aggregate demand.
Because if the Fed says it’s true it must be, right?
Look into my eyes, look deep into my eyes, not around the eyes…
Related links:
FOMC minutes
Fed capitulates: The central bank is broken – FT Alphaville
Richard “I have a problem” Bove – FT Alphaville