Upload
national-press-foundation
View
223
Download
0
Embed Size (px)
Citation preview
7/27/2019 Fundamentals of Monetary Policy with Jon Faust
1/55
Fundamentals of Monetary Policy
Jon Faust
Federal Reserve Board
Jan. 14, 2014
Note: These slides were prepared for presentation at a Mechanics of
Finance Briefing arranged by the Milken Institute and National PressFoundation. These slides are intended only as a primer on the basic
topics covered; they reflects the authors views and not necessarily
those of the Federal Reserve Board or anyone else associated with the
Federal Reserve System.
.1/54
7/27/2019 Fundamentals of Monetary Policy with Jon Faust
2/55
Never explain, never excuse
Montague Norman, Governor, Bank of
England, 19211944
.2/54
7/27/2019 Fundamentals of Monetary Policy with Jon Faust
3/55
FOMC, 2012
The Committee seeks to explain its monetary
policy decisions to the public as clearly aspossible. Such clarity facilitates well-informed
decisionmaking by households and businesses,
reduces economic and financial uncertainty,increases the effectiveness of monetary policy,
and enhances transparency and accountability,
which are essential in a democratic society.(from the statement of longer-run goals and
strategy)
.3/54
7/27/2019 Fundamentals of Monetary Policy with Jon Faust
4/55
Central banks
.4/54
7/27/2019 Fundamentals of Monetary Policy with Jon Faust
5/55
Almost all nations have a central bank
U.S.: Federal Reserve System
U.K.: Bank of England
Nations that share the euro: European
Central Bank(in conjunction with the central banks of each
nation)
.5/54
7/27/2019 Fundamentals of Monetary Policy with Jon Faust
6/55
Central Bank: Main Responsibilities
Monetary policy:Foster financial conditions favorable to stable
spending, production, and inflation. Financial stability
Traditionally: calm financial panics by standing
ready to provide short-term loans to solvent banksthat face runs. This function called lender of last
resort to financial system.
.6/54
7/27/2019 Fundamentals of Monetary Policy with Jon Faust
7/55
Central Bank: Main Responsibilities
Other responsibilities vary a good dealacross central banks
.7/54
7/27/2019 Fundamentals of Monetary Policy with Jon Faust
8/55
Monetary policy
.8/54
7/27/2019 Fundamentals of Monetary Policy with Jon Faust
9/55
Governance and independence
Around the world, monetary policy is oftenmade by a board.
Board is often appointed by thegovernment, but. . .
. . . government cannot dictate or overrulemonetary policy decisions(or fire the policymakers for their policies)
Known as central bank independence
.9/54
7/27/2019 Fundamentals of Monetary Policy with Jon Faust
10/55
Governance and independence
Why independence?A long historical record worldwide suggests that
independence leads to more stable policy andbenefits citizens in the economy.
.10/54
7/27/2019 Fundamentals of Monetary Policy with Jon Faust
11/55
Federal Reserve System
Established by Congress in 1913Modified in some important ways through the
years
.11/54
7/27/2019 Fundamentals of Monetary Policy with Jon Faust
12/55
Federal Reserve System
Federal Open Market Committee (FOMC)makes monetary policy decisions
19 members 7 members of the Board of Governors
of the Federal Reserve System(the Chair and Vice Chair are governors)
12 Presidents of regional FederalReserve Banks
.12/54
7/27/2019 Fundamentals of Monetary Policy with Jon Faust
13/55
Decisionmaking
FOMC has 8 regularly scheduledmeetings per year
FOMC debates and votes on changes tothe stance of monetary policy
Policy set by a vote of 7 governors and 5voting presidents5 of 12 presidents vote on a rotating basis. New
York Fed president always votes.
.13/54
7/27/2019 Fundamentals of Monetary Policy with Jon Faust
14/55
Monetary policy: transparency
.14/54
7/27/2019 Fundamentals of Monetary Policy with Jon Faust
15/55
Transparency: Explaining policy
Modern thinking says policy is moreeffective when the public understands
policy. Policy transparency has come a long way
generally in central banks around the
world. . . but transparency is still a work in progress
.15/54
7/27/2019 Fundamentals of Monetary Policy with Jon Faust
16/55
Federal Reserves Main Communication Tools
FOMC statement released at the end ofeach FOMC meeting.
Chairs press conference follows 4meetings per year
Minutes of the FOMC meeting releasedabout 3 weeks after meeting
After 5 years, full transcript of meeting.
.16/54
7/27/2019 Fundamentals of Monetary Policy with Jon Faust
17/55
Federal Reserves Main Communication Tools
Summary of Economic Projections ofFOMC participants
Chair and other officials testify regularly inCongressincluding a twice yearly Monetary Policy Report
Regular speeches by all policymakers
Website filled with mountains material
http://federalreserve.gov
.17/54
7/27/2019 Fundamentals of Monetary Policy with Jon Faust
18/55
Goal of all this
Explain state of policy
Give rationale for policy
Explain likely future evolution of policy
.18/54
7/27/2019 Fundamentals of Monetary Policy with Jon Faust
19/55
The Feds monetary policy mandate
.19/54
7/27/2019 Fundamentals of Monetary Policy with Jon Faust
20/55
Statutory mandate
Promote maximum employment, stableprices, and moderate long-term interest
ratesThis gives general guidance, but must be filled out
.20/54
7/27/2019 Fundamentals of Monetary Policy with Jon Faust
21/55
In Jan. 2012, FOMC adopted . . .
Consensus statement on longer-run goalsand strategy
FOMC reaffirms each January
.21/54
7/27/2019 Fundamentals of Monetary Policy with Jon Faust
22/55
Why longer-run goals?
From the statement:Inflation, employment, and long-term interest rates
fluctuate over time in response to economic andfinancial disturbances. Moreover, monetary policy
actions tend to influence economic activity and
prices with a lag. Therefore, the Committeespolicy decisions reflect its longer-run goals, its
medium-term outlook, and its assessments of the
balance of risks, including risks to the financialsystem...
.22/54
7/27/2019 Fundamentals of Monetary Policy with Jon Faust
23/55
Stable prices
Does this mean zero inflation? No.
Consensus statement sets a goal of 2
percent inflation
.23/54
7/27/2019 Fundamentals of Monetary Policy with Jon Faust
24/55
Why not zero inflation?
Long history worldwide suggests thatdeflation very bad for employment and
growthDeflation is negative inflation; that is, a falling
general price level
2 percent inflation is judged to be highenough to provide a cushion or bufferagainst deflation
But still low enough to avoid undue costsof inflation
.24/54
7/27/2019 Fundamentals of Monetary Policy with Jon Faust
25/55
Maximum employment
Does the mean Fed aspires to anunemployment rate of zero? No.
.25/54
7/27/2019 Fundamentals of Monetary Policy with Jon Faust
26/55
Maximum employment
Does the mean Fed aspires to anunemployment rate of zero? No.
Consensus statement refers to maximumsustainable employment
.25/54
7/27/2019 Fundamentals of Monetary Policy with Jon Faust
27/55
Why not zero unemployment?
In any dynamic economy there will alwaysbe some unemployment
100% employment is not sustainable The maximum sustainable rate is not
known with precision
FOMC reports its estimate in theSummary of Economic Projectionscurrent range: 5.26.0 percent unemployment rate
.26/54
7/27/2019 Fundamentals of Monetary Policy with Jon Faust
28/55
Moderate long-term interest rates
FOMC judges that best way to achievethis portion of the mandate is to promote
stable prices and maximum employmentThus, this goal is often not separately emphasized
.27/54
7/27/2019 Fundamentals of Monetary Policy with Jon Faust
29/55
How do central banks pursue their goals?
.28/54
7/27/2019 Fundamentals of Monetary Policy with Jon Faust
30/55
Conventional policy
Central bank can control the interest rateat which banks lend to each other for 1
day.generally called an overnight interest rate
In U.S., called the federal funds rate
.29/54
7/27/2019 Fundamentals of Monetary Policy with Jon Faust
31/55
Promoting the goals
Raising or lowering the federal funds ratetarget indirectly affects all other interest
rates . . . . . . and stock prices, home prices, the
exchange value of the dollar against other
currencies, and all other financialconditions
.30/54
7/27/2019 Fundamentals of Monetary Policy with Jon Faust
32/55
Promoting the goals
Raising the federal funds rate target tendsto make financial conditions less favorable
to borrowing and spending.Called less accommodative
Lowering the target makes conditions
more accommodative
.31/54
7/27/2019 Fundamentals of Monetary Policy with Jon Faust
33/55
In terms of the mandate
More accommodative policies tend to . . . promote higher employment
promote higher inflation Less accommodative policies do the
opposite
.32/54
7/27/2019 Fundamentals of Monetary Policy with Jon Faust
34/55
Simple facts about this interest rate tool
It can be powerful
It is blunt and indirect
.33/54
7/27/2019 Fundamentals of Monetary Policy with Jon Faust
35/55
Note also
This interest rate policy moves bothemployment and inflation in the same
directione.g. tending to raise both employment and inflationor lower them
Dont have an interest rate tool to pushone up and the other down
.34/54
7/27/2019 Fundamentals of Monetary Policy with Jon Faust
36/55
Note also
Right now the two sides of the mandateboth call for accommodative policy
Inflation below 2 percent, employment belowmaximum sustainable level
Very often the two goals call for the same
policy
.35/54
7/27/2019 Fundamentals of Monetary Policy with Jon Faust
37/55
When the goals call for different policy
Statement of goals and strategy:When the goals conflict, FOMC takes a balanced
approach to promoting a return to the desiredlevels over time.
.36/54
7/27/2019 Fundamentals of Monetary Policy with Jon Faust
38/55
Monetary policy mechanics and what is
different at present
.37/54
7/27/2019 Fundamentals of Monetary Policy with Jon Faust
39/55
Mechanics
In conventional policy, the FOMC strivesto hit the federal funds rate target by
buying and/or selling governmentsecurities
For example, buying securities increases
bank reserves and tends to push downthe federal funds rate.
.38/54
7/27/2019 Fundamentals of Monetary Policy with Jon Faust
40/55
What is different right now?
U.S. had a financial crisis and deeprecession
led to high unemployment, downward pressure oninflation
Normal response: lower the federal funds
rate target
.39/54
7/27/2019 Fundamentals of Monetary Policy with Jon Faust
41/55
But you can only go so far
Cannot push the federal funds rate belowzero
A negative interest rate means the lender pays theborrower to borrow. Lenders would rather just
keep the funds.
.40/54
7/27/2019 Fundamentals of Monetary Policy with Jon Faust
42/55
Thus,
Once the conventional policy interest ratehits zero the conventional approach
cannot be pursued further Must use unconventional tools to create
the needed accommodation
.41/54
7/27/2019 Fundamentals of Monetary Policy with Jon Faust
43/55
2 main tools
Forward guidance
Large scale purchases of longer-term
securities
.42/54
7/27/2019 Fundamentals of Monetary Policy with Jon Faust
44/55
Forward guidance
Forward guidance is clear communicationabout the conditions under which the
federal funds rate target will remain highlyaccommodative.
Loosely, speaking, FOMC seeks to make
clear that it will promote highlyaccommodative conditions until the job isdone.
The expectation of continuedaccommodation should put downwardpressure on longer-term interest rates.Which tends to stimulate the economy
.43/54
7/27/2019 Fundamentals of Monetary Policy with Jon Faust
45/55
Forward guidance: December FOMC statement
The Committee also reaffirmed its expectation that
the current exceptionally low target range for the
federal funds rate of 0 to 1/4 percent 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
Committees 2 percent longer-run goal, and
longer-term inflation expectations continue to be
well anchored.
.44/54
7/27/2019 Fundamentals of Monetary Policy with Jon Faust
46/55
Forward guidance: December FOMC statement
At least as long, but maybe longer?The Committee now anticipates, based on its
assessment of these factors, that it likely will beappropriate to maintain the current target range for
the federal funds rate well past the time that the
unemployment rate declines below 6-1/2 percent,especially if projected inflation continues to run
below the Committees 2 percent longer-run goal.
.45/54
7/27/2019 Fundamentals of Monetary Policy with Jon Faust
47/55
Large scale purchases of longer term securities
FOMC policies usually affect longer-terminterest rates indirectly through a affecting
an overnight interest rateor through communications about the futurecourse of the overnight interest rate
Instead, the FOMC could purchase alarge amount of longer-term securitiesFOMC is empowered to by Treasury securities and
agency and agency mortgage-backed securities
.46/54
7/27/2019 Fundamentals of Monetary Policy with Jon Faust
48/55
Large scale purchases of longer term securities
Large scale purchases of longer-termsecurities tend to push down the interest
rate on these securitiesputting downward pressure on longer-term interestrates more generally, which should stimulate the
economy
.47/54
7/27/2019 Fundamentals of Monetary Policy with Jon Faust
49/55
December FOMC statement
FOMC had been purchasing $85 permonth in longer-term securities
In December, FOMC reduced rate ofpurchases to $75 billion per monthKnown popularly as a taper
.48/54
7/27/2019 Fundamentals of Monetary Policy with Jon Faust
50/55
December statement: future path of purchases
If incoming information broadly supports the
Committees expectation of ongoing improvement
in labor market conditions and inflation moving
back toward its longer-run objective, the
Committee will likely reduce the pace of asset
purchases in further measured steps at future
meetings.
.49/54
7/27/2019 Fundamentals of Monetary Policy with Jon Faust
51/55
December statement: future path of purchases
Asset purchases are not on a preset course, and
the Committees decisions about their pace will
remain contingent on the Committees outlook for
the labor market and inflation as well as its
assessment of the likely efficacy and costs of such
purchases.
.50/54
7/27/2019 Fundamentals of Monetary Policy with Jon Faust
52/55
Overall
Fed is maintaining a highlyaccommodative policy
To promote return to maximum sustainableemployment and return of inflation to 2 percent
Because federal funds rate target is near
zero, using unconventional tools
.51/54
7/27/2019 Fundamentals of Monetary Policy with Jon Faust
53/55
Overall
Over time, as conditions warrant, Fed willreturn to more conventional policy
.52/54
7/27/2019 Fundamentals of Monetary Policy with Jon Faust
54/55
With this broad sketch. . .
. . . the other speakers will now talk in greater
detail about the effects of unconventionalpolicy in the U.S. and abroad. . .
.53/54
7/27/2019 Fundamentals of Monetary Policy with Jon Faust
55/55
References for some specifics
Basic Federal Reserve structure:http://federalreserve.gov/aboutthefed/
The consensus statement on longer-rungoals and strategy:http://federalreserve.gov/monetarypolicy/
FOMC statements:http://federalreserve.gov/monetarypolicy/fomccalendars.htm