The Fed and Monetary Policy 2007-2013
DePaul University February 14, 2013
Spencer Krane Senior Vice President, Economic Research
The views expressed are my own and not those of the Federal Reserve Bank of Chicago or the Federal Reserve System
0
0 Structure of the Fed
1
1 Functions of the Federal Reserve
Provide financial services to the public, financial institutions, U.S. government, and foreign official institutions
Supervise and regulate banks and some other financial institutions – Safety and soundness of individual institutions – “Macro-prudential” regulation. Puts greater emphasis on the stability of the system as a whole – Dodd-Frank bill increased the Fed’s role in financial regulation
Conduct monetary policy – Influence the amount and/or cost of credit with aim of macroeconomic stabilization
2
2 Federal Reserve Districts
3
3 Federal Reserve Structure
Board of Governors – Located in Washington DC – Seven members appointed by the U.S. president to 14 year terms – Chairman is Ben Bernanke
Federal Reserve Banks – 12 Banks spread around the country – Technically owned by member commercial banks – Reserve Bank presidents appointed by Boards of Directors and approved by the Board of Governors
4
4 Regional Banks
Functional – Financial services – Discount window – Supervision and Regulation – FOMC
Information gathering and dissemination – Boards of Directors – Advisory Councils (Bankers, Agriculture, Small Business, Labor, Academics) – Business contacts – Community and industry forums – Research and research sponsorship
5
5 The Federal Reserve Board of Governors
1 2
Ben S. Bernanke Janet L. Yellen
5 6
Elizabeth A. Duke Daniel K. Tarullo Sarah Bloom Raskin Jeremy C. Stein Jerome H. Powell
6
6 Presidents of the District Reserve Banks
1 2 3 4
Eric S. Rosengren William C. Dudley Charles I. Plosser Sandra Pianalto First District - Boston Second District - New York Third District - Philadelphia Fourth District - Cleveland 5 6 7 8
Jeffrey M. Lacker Dennis P. Lockhart Charles L. Evans James B. Bullard Fifth District - Richmond Sixth District - Atlanta Seventh District - Chicago Eighth District - St. Louis 9 10 11
Naryana Kocherlakota Esther L. George Richard W. Fisher John C. Williams 7 Ninth District - Minneapolis Tenth District - Kansas City Eleventh District - Dallas Twelfth District - San Francisco The Federal Open Market Committee (FOMC)
8 Federal Open Market Committee (FOMC)
Makes the monetary policy decisions
7 members of Board of Governors
5 of the Reserve Bank presidents on a rotating basis – New York – Chicago or Cleveland – Boston, Philadelphia, or Richmond – Atlanta, Dallas, or St. Louis – Minneapolis, Kansas City, or San Francisco – All 12 presidents participate in meetings
All 19 participants focus on the appropriate national policy
9
9
2012 FOMC Calendar Minutes: 434 KB PDF | Press Conference HTML January 24-25* Statement Projections Materials: (Released February 15, PDF | Accessible Figures 2012) Longer-Run Goals and Policy Strategy Minutes: 251 KB PDF | March 13 Statement HTML (Released Apr 3, 2012)
Press Conference Minutes: 419 KB PDF | April 24-25* Statement Projections Materials: HTML PDF | Accessible Figures (Released May 16, 2012)
Press Conference Minutes: 383 KB PDF | June 19-20* Statement Projections Materials: HTML PDF | Accessible Figures (Released July 11, 2012)
Minutes: 295 KB PDF | July/August 31-1 Statement HTML (Released Aug 22, 2012)
Press Conference Minutes: 391 KB PDF | September 12-13* Statement Projections Materials: HTML PDF | Accessible Figures (Released October 4, 2012)
Related Current FAQs Minutes: 262 KB PDF | HTML October 23-24 Statement (Released November 14, 2012)
Press Conference Minutes: 388 KB PDF | December 11-12* Statement Projections Materials: HTML PDF | Accessible Figures (Released Jan 3, 2013)
10 FOMC Meetings
11
11 What Happens at an FOMC Meeting?
Preliminaries – Administrative matters – Often presentation on special topic
Report from the “Desk” – NY Fed Markets Group: What’s up in the markets
Tealbook Part A presentation: The economic outlook – FOMC participants ask questions
“Go Around I”: Members present views on regional and national outlook – Supposed to avoid talking about policy; people cheat a little
12
12 What Happens at an FOMC Meeting?
Tealbook Part B presentation: The policy options – The policy prescription – The words
“Go Around II”: Policy discussion – Participants give views of appropriate policy
The Vote: The Chairman gives his sense of the consensus – Only members vote
Post-decision activities – Often another presentation of a special topic – Lunch
13
13 Monetary Policy in the Abstract
14
14 The Federal Reserve’s Dual Mandate
Federal Reserve Act: Section 2a. Monetary Policy Objectives
The Board of Governors of the Federal Reserve System and the Federal Open Market Committee shall maintain long run growth of the monetary and credit aggregates commensurate with the economy's long run potential to increase production, so as to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates.
15
15 Monetary Policy Goals: Output
We would like to see fully utilized productive resources
Monetary policy can help close gaps between actual and “potential” economic output
But if over-stimulate the economy eventually results in increasing inflation
In the long run – Potential output is the best can do on a sustainable basis – In the long run, the Fed can’t make the economy grow faster than its potential (classical dichotomy)
16
16 Monetary Policy Goals: Price Stability
Price stability provides the environment necessary to meet all the other goals of monetary policy
An environment of price stability makes planning easier – Price stability improves the workings of the price system -- high and variable inflation jams the signals sent by relative prices – Price stability may also lower long-term interest rates by reducing uncertainty
Usually discussed in terms of cost of inflation being too high or too low
17
17 January 2012 Principles Statement: Long Run Goals and Policy Strategy Price stability – Sets 2% objective for PCE inflation – Target is for an average over medium term – it is not a ceiling – Explicit statement should help anchor expectations
Full employment – Employment goal may change over time for non-monetary reasons – 5.2-6.0% unemployment currently consistent with mandate – Seek an economy operating at its level of potential output
Balanced approach – Balanced reaction when shocks move economy from objectives – Takes account of lags and other limits in effects of monetary policy
18 18 Classical Dichotomy Between P and Q
Real quantities and relative prices determined by supply and demand in markets for real quantities (labor, goods, services)
Given real quantities, monetary policy determines nominal quantities (prices in terms of dollars) and inflation
M V(prel) = P Q(prel)
Monetary neutrality: idea that variations in the supply of money are irrelevant to the determination of real quantities
A reasonable idea in the long-run – Why should the number of pieces of paper with pictures of dead presidents make a big difference to anything? – Capital, labor, and technology determine real output
Important violations in short run 19
19 Monetary Policy and the Real Economy
Prices and inflation are “sticky” in the short run – More money doesn’t immediately raise prices proportionately
Monetary policy does affect the real economy – At least in the short and medium run
Usually operate by changing the federal funds rate
Changes in short-term interest rates influence – Long-term real interest rates – Exchange rates and asset values
These then affect saving and investment decisions, which in turn affect employment and output
20
20 Short-Run Monetary Non-Neutrality
Evidence from Christiano, Eichenbaum, and Evans (2005)
21 21 Simple Monetary Policy Rules
To achieve goals, central banks tend to set policy rates in a way that depends on: – Inflation relative to target (π vs. 2 percent) – The state of the real economy (y vs. y*)
E.g., Taylor’s 1999 rule :
– i = 2 + π + 0.5(π – 2) + 1.0(y – y*)
A description about how policy “usually” works
But various special factors can make it necessary to deviate from simple rules
22 22 Economic Conditions and Outlook
23
23 GDP Growth Forecast
Real GDP Growth (percent) 9 GDP Growth (% change at annual rate) GDP Growth (yr/yr % change)
6
FOMC Q4/Q4 Forecasts* 3
FOMC Long-Run Projection*
0 Q4-2012
-3
-6
-9 2000 '02 '04 '06 '08 '10 '12 '14
*Midpoint of the forecasts made by the FOMC participants, December 2012 24
24 GDP Level Forecast
Actual and Potential GDP (Bils. 2005$) 16000
CBO Potential
FOMC 14000 forecasts
Actual Q4-2012
12000
10000 1999 '01 '03 '05 '07 '09 '11 '13 '15
25
25 Unemployment Forecast
Unemployment Rate (percent) 12
9 FOMC Forecasts*
Jan-2013 6
CBO Short-run FOMC Long-Run Projection* NAIRU
3
0 1960 '70 '80 '90 2000 '10
*Midpoint of the forecasts made by the FOMC participants, December 2012 26
26 Inflation Forecast
PCE Price Index (12-month percent change) 5
4 Total Core
3
FOMC Long-Run Target* 2
FOMC Q4/Q4 Forecasts* 1 Dec-2012
0
-1
*Midpoint of the forecasts made by the FOMC participants, December 2012 27
27 How Did We Get In This Situation?
Housing market boom and bust – Period of rapidly rising home prices, loose lending, and booming construction – Unwind was big drag on economy 2006-2009
Financial market disruption – Surprising financial market fragility – Banks and “shadow banks” both highly stressed – Reduced credit availability slowed economy
Business and consumer pessimism – Many disturbing events of late 2008 – Businesses and consumers began to plan for the worst
As a result we got a very bad recession 28
28 Why Has the Recovery Been so Disappointing?
Long-lasting damage from the recession – Balance sheet restructuring by households, nonfinancial businesses and financial institutions – Loss or worker skills and capital formation
Additional shocks – European crisis – Fiscal cliff issues in U.S.
Business and consumer pessimism and uncertainty – Precautionary behavior
Monetary policy runs into the zero lower bound
29
29 Monetary Policy 2008- 2013
30
30 Key Elements of Fed Response
Credit easing/liquidity provision – Target specific stress points in financial markets through various liquidity facilities
Exceptional support – Manage distress at systemically important institutions
Highly accommodative monetary policy
31
31 Impact Of Aggregate Demand Decline
Normal Adjustment Liquidity Trap
(r=i-π) Real interest Aggregate Aggregate rate = nominal Supply Supply interest rate - inflation
Old r Old r
Old Aggregate Demand Output Gap New r Zero Bound r = -π
Old Aggregate Equilibrium Demand Rate New Aggregate New Aggregate Demand Demand
Y* Output Output Y*
32 32 32 Funds Rate: Low, but Constrained at Zero Bound
Federal Funds Rate (percent) 9
6 History Central Tendency of FOMC Long-Run Projection
3
0 Q4-2012 Taylor (1999) Rule Benchmark (CBO Potential) -3
-6 2000 '02 '04 '06 '08 '10 '12
33
33 Monetary Policy At The Zero Lower Bound What to do when can’t cut current short-term rate any further?
Lower longer-term interest rate – Option 1: Cut expectations of future short-term rates
Current long-term rates depend on average of expected future short-term rates
Forward guidance on future policy rates
– Option 2: Buy long-term bonds to reduce term premium
Term premia = difference between average expected short-term rates and the long-term rate
Duration, credit, and inflation uncertainty
34 34
Opion 2: Large Scale Asset Purchases (LSAP)
LSAP I (11/08): $600 bill agency debt/MBS
LSAP Ia (3/09): $850 bill agency debt/MBS; $300 bill Treas.
LSAP II (11/10): $600 bill Treas.
MEP (9/11): Exchange $400 bill short-term for $400 bill long- term Treas.
MEP extension (6/12): Extend MEP through end of 2012
LSAP III (9/12): $40 bill per month MBS, no fixed end date -- “until labor market outlook improved substantially”
LSAP IIIa (12/12): $40 bill per month MBS and $45 bill per month long-term Treas; no fixed end date
35
35 Non-Standard Policies Adding More Stimulus
Federal Reserve Assets (Bils. $) 06-Feb-2013W 3000
Purchase Programs ($2,939.1 bil.) 2500 TALF ($1.3 bil.) Liquidity Facilities ($108.0 bil.) Systemic Lending ($30.8 bil.) 2000 Other Assets ($493.6 bil.)
Goals: 1500 • Lending to improve liquidity and reduce unusual risk spreads 1000 •LSAP to lower long- term real interest rates
500
0 2007 2008 2009 2010 2011 2012 2013
36
36 Monetary Policy and LSAPs
Federal Funds Rate (percent)
6 Central Tendency of FOMC Long-Run Projection
3
Dec-2012
0
Rate Adjusted for LSAPs (illustrative)
-3 Taylor (1999) Rule Benchmark (CBO Potential)
-6 2006 2007 2008 2009 2010 2011 2012
37
37 Option 1: Forward Guidance on Funds Rate
Economic conditions likely to warrant exceptionally low level of the funds rate:
12/08: “for some time”
3/09: “for an extended period”
8/11: “at least through mid 2013”
1/12: “at least through late 2014”
9/12: “at least through mid 2015”
38
38 Monetary Policy At The Zero Lower Bound
Response to August 9, 2011 FOMC Statement Change from "extended period" to "at least mid-2013" 1.2
1.0
0.8
0.6 percent
0.4
-14 bp
0.2
0.0 Aug-11 Feb-12 Aug-12 Feb-13 Aug-13 Feb-14 8-Aug-11 August 8 average 10-Aug-11 August 10 average 39 39 Forward Guidance on Funds Rate, cont.
9/12 cont. “…the Committee expects that a highly accommodative stance of monetary policy will remain appropriate for a considerable time after the economic recovery strengthens….at least through mid-2015.”
12/12: “…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 of a percentage point above the Committee’s 2 percent long-run goal, and longer-term inflation expectations continue to be well- anchored.
40
40 Funds Rate Under Alternative Policy Rules
Federal Funds Rate (percent) 5 Optimal Policy: 2 2 2 Min ∑t (π – π*) + (u – u*) + (i – i-1) 4
3 Optimal Control Taylor 1999 Taylor 1993 2
1
0 2011 2012 2013 2014 2015 2016 2017 2018
Source: Janet L. Yellen, “The Economic Outlook and Monetary Policy,” New York, 11 April 2012 41
41 Forecasts Under Alternative Policy Rules
Unemployment Rate PCE Inflation (percent) (4-quarter percent change) 10 4.0
9 3.5 Optimal Control Optimal Control Taylor 1999 Taylor 1999 Taylor 1993 Taylor 1993 8 3.0
7 2.5
6 2.0
5 1.5
4 1.0 2011 2012 2013 2014 2015 2016 2017 2018 2011 2012 2013 2014 2015 2016 2017 2018
Source: Janet L. Yellen, “The Economic Outlook and Monetary Policy,” New York, 11 April 2012 42
42 Target Federal Funds Rate at Year End
(percent)
6
5
4
3
2
1
0 2012 2013 2014 2015 Long-Run Source: Projections made at the December 11-12, 2012 FOMC meeting, available at www.federalreserve.gov 43 43 Appendix
44
44 Monetary Expansion
Current Period 1929-1933 (Index, Jan-07=100) (Index, Jan-1929=100) 300 300
250 250 M2 M2 Monetary Base Monetary Base
200 200
Jan-2011 150 150
100 100
50 50 2007 '08 '09 '10 '11 1929 '30 '31 '32 '33
45
45 Expanded Federal Reserve Liquidity Facilities
Liquidity/Credit Facilities with Portfolio Liquidity Facilities with Financial Institutions Other Other Investors and Borrowers Purchases
Money Market Mutual Funds Consumer and GSEs and Depository Other Central Primary Specific and Small Business Residential Institutions Banks Dealers Institutions Commercial Credit Mortgages Paper Markets
Discount PDCF* AMLF* Bear Stearns* window
GSE debt and Swap Lines TALF* MBS TAF TSLF* CPFF* purchases AIG*
Interest on Citigroup/Bank TOP* MMIFF* reserves of America
* Authorized under Section 13(3) of the Federal Reserve Act – “unusual and exigent circumstances”
46
46