The Future of Monetary Policy

Remember when the hottest question about negative interest rates in the United States was their legality? Here’s former Federal Reserve Chair Janet Yellen addressing the issue in a 2016 congressional testimony:

“We decided not to lower interest rates, the IOER, to zero or into negative territory, and we didn’t fully look at the legal issues around that. I would say that remains a question that we still would need to investigate more thoroughly.”

It appears the investigation has been completed since then. In recent months, amid the Fed’s first interest rate easing cycle since the financial crisis, FOMC members have been forced to address questions about negative interest rates again. The focus now, though, has turned to their effectiveness. The minutes from the October FOMC meeting gave us some insight into how Fed officials are thinking:

“The briefing also discussed negative interest rates, a policy option implemented by several foreign central banks. The staff noted that although the evidence so far suggested that this tool had provided accommodation in jurisdictions where it had been employed, there were also indications of possible adverse side effects. Moreover, differences between the U.S. financial system and the financial systems of those jurisdictions suggested that the foreign experience may not provide a useful guide in assessing whether negative rates would be effective in the United States.”

Of course, the ‘jurisdictions where it had been employed’ is code for Europe and Japan. The European Central Bank was the first to take rates below zero, followed by the the Bank of Japan in early 2016. Meanwhile, the Fed succeeded in raising rates by more than 2% before being forced toward an easier approach. The FOMC still has room to work with, but the average easing cycle has seen rates cut by substantially more than 2.5% – enough to push the Federal Funds into negative territory for the first time.

Judging by the committee’s comments, it doesn’t look like we’re headed there in the near future. The minutes continued:

“All participants judged that negative interest rates currently did not appear to be an attractive monetary policy tool in the United States.”

With the zero lower bound so close, and little, if any, support to send rates negative, it’s no surprise the Fed is exploring it’s other options. Balance-sheet tools are clearly the preferred mechanism for future support.

“Participants generally agreed that the balance sheet policies implemented by the Federal Reserve after the crisis had eased financial conditions and had contributed to the economic recovery, and that those tools had become an important part of the Committee’s current toolkit.”

But the balance sheet discussion didn’t stop at simply supporting prior quantitative easing strategies.

“In considering policy tools that the Federal Reserve had not used in the recent past, participants discussed the benefits and costs of using balance sheet tools to cap rates on short- or long-maturity Treasury securities through open market operations as necessary.”

Though some participants pushed back on this last policy option, the push-back was mostly technical in nature – namely, concerns about how other policy tools, like the Federal Funds Rate, would be adversely affected.

In conclusion, the members pledged to continue their review of alternative policy options over the coming months, but opined that fiscal policy would be an important factor during any future downturns. Government spending has been a recurring subject among central bankers, with new ECB head Christine Lagarde using a speech last week to echo her predecessor’s calls for fiscal stimulus to support the European economy.

In a world that seems to be more politically divided with each passing day, it’s hard to know how fiscal policy will unfold. But with or without help, it sounds like central bankers are willing to do whatever it takes.

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