By Steven K. Beckner
In addition to moving away from a zero funds rate, Rudebusch says
“an important part of the Fed’s exit strategy involves returning the
level and composition of its balance sheet to pre-crisis norms.”
And “since conventional and unconventional Fed policies provide
complementary monetary stimulus,” he says “the renormalizations of the
funds rate and the Fed’s portfolio of securities should be coordinated.”
However, Rudebusch gives small comfort to those, such as
Philadelphia Fed President Charles Plosser, who would like to see the
Fed sell off assets “sooner rather than later.”
“In theory, the Fed could respond to a faster or slower economic
recovery by adjusting both the pace of tightening of the funds rate and
the speed of the reductions in its securities holdings,” he writes.
“However, there is little historical experience to help predict the
timing and magnitude of the effects of selling securities.”
“This uncertainty suggests that balance sheet renormalization
should proceed cautiously and that short-term interest rates should
remain the key tool of monetary policy,” he goes on, noting that, in
fact, the minutes of the April FOMC meeting show that a majority of the
FOMC “preferred beginning asset sales some time after the first increase
in the FOMC’s target for short-term interest rates.”
Contrary to the fears of Plosser and others that the sheer size of
the Fed’s balance sheet could awaken inflation, Rudebusch writes, “the
doubling of the Fed’s balance sheet has had no discernible effect on
long-run inflation expectations.”
And he again cites the BOJ’s experience: “This insensitivity of
inflation to an enlarged central bank balance sheet is consistent with
Japan’s decade-long spell of price deflation.”
“A second worry about a continuing high level of bank reserves is
that they may impede the use of short-term interest rates as the
monetary policy instrument,” he goes on. “However, the experience of
foreign central banks suggests that the Fed will be able to control the
level of short-term interest rates by varying the interest rate on bank
reserves.”
As for concerns that continuing to hold large amounts of Treasury
and agency securities will be seen as monetizing the debt or allocating
credit, Rudebusch simply responds, “with Fannie Mae and Freddie Mac in
government conservatorship, the delineation between Treasury and agency
securities has been greatly blurred.”
Though he couches much of his paper in a theoretical vein, drawing
on the implications of a policy “rule of thumb,” Rudebusch takes those
implications to heart in his conclusion.
“Many predict that the economy will take years to return to full
employment and that inflation will remain very low,” he writes. “If so,
it seems likely that the Fed’s exit from the current accommodative
stance of monetary policy will take a significant period of time.”
(2 of 2)
** Market News International **
[TOPICS: M$$CR$,M$U$$$,MMUFE$,MGU$$$,MFU$$$,M$$BR$]
