— Simulations Suggest Highly Accommodative Conditions ‘For Many Years’
WASHINGTON (MaceNews) – The Federal Open Market Committee most recent meeting saw participants discuss all the pandemic-related effects and probabilities already covered in Fed speeches and comments since. However the FOMC minutes released Wednesday also had a unique disclosure, the staff briefing for participants on yield curve control, forward guidance and asset purchases. The minutes’ text of that briefing and accompanying discussion follows:
Discussion of Forward Guidance, Asset Purchases, and Yield Curve Caps or Targets
Participants discussed tools for conducting monetary policy when the federal funds rate is at its effective lower bound (ELB). The discussion addressed two topics: (1) the roles of forward guidance and large-scale asset purchase programs in supporting the attainment of the Committee’s maximum-employment and price-stability goals and (2) in light of the foreign and historical experience with approaches that cap or target interest rates along the yield curve, whether such approaches could be used to support forward guidance and complement asset purchase programs.
The staff briefing on the first topic focused on outcome-based forward guidance for the federal funds rate – which ties changes in the target range for the federal funds rate to the achievement of specified macroeconomic outcomes, such as reaching a given level of the unemployment rate or inflation – and asset purchase programs of the kind used during and following the previous recession. The staff presented results from model simulations that suggested that forward guidance and large-scale asset purchases can help support the labor market recovery and the return of inflation to the Committee’s symmetric 2 percent inflation goal.
The simulations suggested that the Committee would have to maintain highly accommodative financial conditions for many years to quicken meaningfully the recovery from the current severe downturn. The briefing addressed factors that might alter the potency of forward guidance and asset purchase programs, along with a number of considerations for the design of these actions. The staff cautioned that businesses and households might not be as forward looking as assumed in the model simulations, which could reduce the effectiveness of policies that are predicated on influencing expectations about the path of policy several years into the future. Alternatively, prompt and forceful policy actions by the Committee might help focus the public’s expectations around better outcomes or reduce perceived risks of worst-case scenarios, which could generate more immediate macroeconomic benefits than those featured in the staff analysis.
The second staff briefing reviewed the yield caps or targets (YCT) policies that the Federal Reserve followed during and after World War II and that the Bank of Japan and the Reserve Bank of Australia are currently employing. These three experiences illustrated different types of YCT policies: During World War II, the Federal Reserve capped yields across the curve to keep Treasury borrowing costs low and stable; since 2016, the Bank of Japan has targeted the 10-year yield to continue to provide accommodation while limiting the potential for an excessive flattening of the yield curve; and, since March 2020, the Reserve Bank of Australia has targeted the three-year yield, a target that is intended to reinforce the bank’s forward guidance for its policy rate and to influence funding rates across much of the Australian economy. The staff noted that these three experiences suggested that credible YCT policies can control government bond yields, pass through to private rates, and, in the absence of exit considerations, may not require large central bank purchases of government debt.
But the staff also highlighted the potential for YCT policies to require the central bank to purchase very sizable amounts of government debt under certain circumstances—a potential that was realized in the U.S. experience in the 1940s—and the possibility that, under YCT policies, monetary policy goals might come in conflict with public debt management goals, which could pose risks to the independence of the central bank.
In their discussion of forward guidance and large-scale asset purchases, participants agreed that the Committee has had extensive experience with these tools, that they were effective in the wake of the previous recession, that they have become key parts of the monetary policy toolkit, and that, as a result, they have important roles to play in supporting the attainment of the Committee’s maximum-employment and price-stability goals.
Various participants noted that the economy is likely to need support from highly accommodative monetary policy for some time and that it will be important in coming months for the Committee to provide greater clarity regarding the likely path of the federal funds rate and asset purchases. Participants generally indicated support for outcome-based forward guidance.
A number of participants spoke favorably of forward guidance tied to inflation outcomes that could possibly entail a modest temporary overshooting of the Committee’s longer-run inflation goal but where inflation fluctuations would be centered on 2 percent over time. They saw this form of forward guidance as helping reinforce the credibility of the Committee’s symmetric 2 percent inflation objective and potentially preventing a premature withdrawal of monetary policy accommodation. A couple of participants signaled a preference for forward guidance tied to the unemployment rate, noting that it would be more credible to focus on labor market outcomes that have been achieved in the recent past or that – given how high the unemployment rate currently is—such guidance would clearly signal a high degree of accommodation for an extended period.
A few others suggested that calendar-based guidance – which specifies a date beyond which accommodation could start to be reduced – might be at least as effective as outcome-based guidance. They noted that calendar-based guidance had been very effective when the Committee used it in 2011 and 2012 or that it would be very challenging to provide credible outcome-based guidance in light of the substantial uncertainty surrounding the current economic outlook. Regardless of the specific form of forward guidance, a couple of participants expressed the concern that policies that effectively committed the Committee to maintaining very low interest rates for a long time could ultimately pose significant risks to financial stability.
Participants agreed that asset purchase programs can promote accommodative financial conditions by putting downward pressure on term premiums and longer-term yields. Several participants remarked that declines in the neutral rate of interest and in term premiums over the past decade and prevailing low levels of longer-term yields would likely act as constraints on the effectiveness of asset purchases in the current environment and noted that these constraints were not as acute when the Committee implemented such programs in the wake of the Global Financial Crisis. These participants noted, however, that large-scale asset purchases could still be beneficial under current circumstances by offsetting potential upward pressures on longer-term yields or by helping reinforce the Committee’s commitment to maintaining highly accommodative financial conditions. A few participants questioned the desirability of large-scale asset purchases following the current purchases to support market functioning, noting that they likely would lead to a further considerable expansion of the Federal Reserve’s balance sheet or have potentially adverse implications for financial stability.
In their discussion of the foreign and historical experience with YCT policies and the potential role for such policies in the United States, nearly all participants indicated that they had many questions regarding the costs and benefits of such an approach. Among the three episodes discussed in the staff presentation, participants generally saw the Australian experience as most relevant for current circumstances in the United States. Nonetheless, many participants remarked that, as long as the Committee’s forward guidance remained credible on its own, it was not clear that there would be a need for the Committee to reinforce its forward guidance with the adoption of a YCT policy.
In addition, participants raised a number of concerns related to the implementation of YCT policies, including how to maintain control of the size and composition of the Federal Reserve’s balance sheet, particularly as the time to exit from such policies nears; how to combine YCT policies – which at least in the Australian case incorporate aspects of date-based forward guidance – with the types of outcome-based forward guidance that many participants favored; how to mitigate the risks that YCT policies pose to central bank independence; and how to assess the effects of these policies on financial market functioning and the size and composition of private-sector balance sheets. A number of participants commented on additional challenges associated with YCT policies focused on the longer portion of the yield curve, including how these policies might interact with large-scale asset purchase programs and the extent of additional accommodation they would provide in the current environment of very low interest rates. Some of these participants also noted that longer-term yields are importantly influenced by factors such as longer-run inflation expectations and the longer-run neutral real interest rate and that changes in these factors or difficulties in estimating them could result in the central bank inadvertently setting yield caps or targets at inappropriate levels. A couple of participants remarked that an appropriately designed YCT policy that focused on the short-to-medium part of the yield curve could serve as a powerful commitment device for the Committee. These participants noted that, even if market participants currently expect the federal funds rate to remain at its ELB through the medium term, the introduction of an effective YCT policy could help prevent those expectations from changing prematurely – as happened during the previous recovery – or that the size of a large-scale asset purchase program, which also poses risks to central bank independence, could be reduced by an effective YCT policy. All participants agreed that it would be useful for the staff to conduct further analysis of the design and implementation of YCT policies as well as of their likely economic and financial effects.
A number of participants emphasized that, when assessing the potential roles that different monetary policy tools might play to support the attainment of the Committee’s goals, it was important to think about how various policy tools could be used in coordination as part of the Committee’s overall strategy to achieve its dual-mandate objectives. In addition, various participants noted that clear communications with the public are central to the efficacy of all policy tools and that, therefore, the Committee should complete its monetary policy framework review in the near term, including revising the Statement on Longer-Run Goals and Monetary Policy Strategy. Such a revised statement would communicate to the public how the Committee views its policy goals and provide additional context to the Committee’s policy actions.
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