Back when I was an undergrad and again when I was teaching money and banking, we taught that the Fed had three tools it could use to control monetary policy for the United states:
- Open market transactions
- The discount rate
- changing the reserve requirements of commercial banks.
My, how times have changed.
Listening to the Charles Plosser and James Bullard, presidents, respectively, of the Philadelphia and St. Louis Feds, it now appears that the Fed has three different tools of monetary policy:
- the Federal Funds rate (the rate charged in the overnight lending market... most likely an evolutionary development from the discount rate). The Fed has to engage in open market transactions to manipulate this rate.
- Quantitative Easing. These are just open market transactions, but instead of the Fed's buying (or selling in some instances) Treasury Bills in the open market, QE is done with longer term Treasury Bonds and with Mortgage-Backed Securities [ 8-( ]. The latter is also referred to as the "asset purchase program". It has had the effect of keeping long-term interest rates below what they might otherwise be. It has also had the effect of bailing out the holders of many of the MBSs and of keeping the interest incomes of widows and pensioners depressed. This is the tool/policy about which there seems to be considerable "discussion" at the Fed Open Market Committee meetings, with some members wanting the programme wound down soon (e.g. Plosser) and others wanting to take more of a wait-and-see stance (e.g. Bullard).
- Forward Guidance. From the Fed's website
Through "forward guidance," the Federal Open Market Committee provides an indication to households, businesses, and investors about the stance of monetary policy expected to prevail in the future. By providing information about how long the Committee expects to keep the target for the federal funds rate exceptionally low, the forward guidance language can put downward pressure on longer-term interest rates and thereby lower the cost of credit for households and businesses, and also help improve broader financial conditions. [EE: groan. Fed policy should be monetary stability, not providing lower cost credit. Transparency might help with stability by cushioning against the effects of regime change.]
Following their December 2012 meeting, Federal Reserve policymakers indicated that they anticipated that a 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 1/2 percentage point above the Committee's 2 percent longer-run goal, and
- longer-term inflation expectations continue to be well anchored.
Those are the thresholds that Presidents Plosser and Bullard were mentioning and about which I posted yesterday. Not mentioned was one of the big killers that the Fed used and which has created all that soaked up liquidity in the form of banks' excess reserves: paying interest on reserves held at the Fed. Changing this rate could have a really big impact on the money supply, price inflation, and aggregate demand.
My attendance at the summit is supported by several sponsors, including the Department of Economics at The University of Regina.