Thank you very much. I would like to give special thanks to the staff, some of whom are here and some of whom are not, for an extraordinary amount of work on these difficult topics over a short period of time. We very much appreciate those efforts.
Are there questions for Brian or Steve or anyone else? If there are no questions, we’re ready for the go-round on this topic. I’d like to ask your indulgence. There’s an awful lot here, and I’d like to go first this time and try to clear out some underbrush and to lay down some issues in the hope that it will perhaps focus our discussion a bit more.
As you know, we are at a historic juncture—both for the U.S. economy and for the Federal Reserve. The financial and economic crisis is severe despite extraordinary efforts not only by the Federal Reserve but also by other policymakers here and around the world. With respect to monetary policy, we are at this point moving away from the standard interest rate targeting approach and, of necessity, moving toward new approaches. Obviously, these are very deep and difficult issues that we are going to have to address collectively today and tomorrow. I want to say that, although we are certainly moving in a new direction and the outlines of that new direction are not yet clear, this is a work in progress. The discussion we’re having today is a beginning. It’s not a conclusion. Everyone can rest assured that this conversation is going to continue for additional meetings, and today we’re not going to be setting in stone an approach that will be used indefinitely. In fact, it would be hubristic to do so, given all the uncertainties and changes that we face. I’m not going to try to address all of these questions, but I thought it would be useful for me to talk a bit, first, about nontraditional policies and then, second, about the important issue of governance, which I know a lot of people are concerned about.
So let me start, first, with nontraditional policies. I want to note that we are working and we should continue to work to improve our control of the effective funds rate. The interest rate paid on reserves is not currently sufficient to keep the rate at the target. That’s for a lot of reasons with which you are all familiar. I would just note that the staff is still working. We should not give up on that. The interest rate on reserves may be more effective as people get used to it, as balance sheet constraints ease, and as the rate gets higher if we decide to raise rates. So I think that is still a tool that we should keep and be aware of. There are other strategies—opening term accounts of various kinds, taking steps to encourage arbitrage, using Treasury bills, or perhaps issuing our own bills. In fact, we have had a lengthy discussion in this Committee of alternative structures for implementing monetary policy that involve different ways of setting up reserve requirements.
So first of all, let’s just acknowledge that, although we are not keeping the effective funds rate at the target currently, we should not assume that that’s always going to be the case. We do have some optionality in that direction. That being said, it’s obvious that the effective funds rate now is quite low, and given the amount of excess reserves in the system, we’re going to have to find other ways at least in the near term to address the economic crisis. One approach, as was discussed by Steve and others, is communications. Here, in particular, I think, we are at early stages. I don’t think we’re going to come to any conclusions today. There is a lot of interest in terms of possibilities. The one thing I would say is that, if we do use communications as a way of providing information about future policy moves, we should be very careful to make those interest rate forecasts, if you will, conditional on the state of the economy. It should be very clear, if we give forward guidance of some kind, that the evolution of the policy rate will depend on how the economy evolves. The more clarity we can provide in that direction, the more effective our policy will be and the less problem we will have exiting from that strategy in the future.
The statements that were circulated in the Bluebook gave two examples just for discussion, both of them in alternative A. In paragraph 2, there was some suggested language for using an inflation target as a way of managing expectations. Let me just read the sentence: “In support of its dual mandate, the Committee will seek to achieve a rate of inflation, as measured by the price index for personal consumption expenditures, of about 2 percent in the medium term.” The idea there would be to try to stabilize inflation expectations, avert deflationary expectations, and keep real rates lower than they otherwise would be. The 2 percent in that statement is a placeholder. Obviously if we do this, we would have to talk more about what 2 percent means. Is it a permanent level? Is it a temporary number? But that is one strategy.
I would add that, of course, as we have discussed, adopting what might be a de facto inflation target is a pretty big deal, and if we decide to do that, I would like to have some opportunity to consult with the Congress appropriately. But if we decide to go in this direction, I do think that this might be a good time because it is certainly not a negative as far as employment growth is concerned in this context, and so it might be easier to explain.
The other example of communication, also in alternative A, ties policy to economic forecasts. “The Committee anticipates that weak economic conditions are likely to warrant federal funds rates near zero for some time.” I note that this is a forecast of policy rather than a commitment to policy, but it does provide some information about the Committee’s expectations and should affect market rates. So, again, I think we’re at early stages of this particular approach, but it may be promising, and I hope today’s discussion will provide some insight.
The second general approach to conducting nontraditional monetary policy is by use of the balance sheet. We have already begun to do this to some extent, as you know. In some respects our policies are similar to the quantitative easing of the Japanese, but I would argue that, when you look at it more carefully, what we’re doing is fundamentally different from the Japanese approach. Let me talk about that a bit. The Japanese approach, the quantitative easing approach, was focused on the liability side of the balance sheet—specifically the quantity of bank reserves, the monetary base, or however you want to put it, in the system. The theory behind quantitative easing was that providing enormous amounts of very cheap liquidity to banks, as Steve discussed, would encourage them to lend and that lending, in turn, would increase the broader measures of the money supply, which in turn would raise prices and stimulate asset prices, and so on, and that would suffice to stimulate the economy. Again, the focus of the quantitative easing was on the liability side, and indeed, there were targets, as you know, for the amount of excess reserves or reserves in the system. I think that the verdict on quantitative easing is fairly negative. It didn’t seem to have a great deal of effect, mostly because banks would not lend out the reserves that they were holding. The one thing that it did seem to do was affect expectations of policy rates because everyone understood it would take some time to unwind the quantitative easing. Therefore, that pushed out into the future the increase in the policy rate.
So I would argue that what we are doing is different from quantitative easing because, unlike the Japanese focus on the liability side of the balance sheet, we are focused on the asset side of the balance sheet. In particular, we have adopted a series of programs, all of which involve some type of lending or asset purchase, which has brought onto our balance sheet securities other than the typical Treasuries that we usually transact in. You are all aware of the lending facilities for banks and dealers, the swaps with foreign central banks, the promised purchases of MBS, the various credit facilities for which even I do not know all the acronyms anymore. [Laughter] In this case, rather than being a target of policy, the quantity of excess reserves in the system is a byproduct of the decisions to make these various types of credit available. I think that’s a very different strategy, and Bill gave some evidence—we can debate it further—that these different policies have had some effects on the markets at which they’re aimed.
Again, to distinguish between the balance-sheet, quantitative-easing, liability-side approach and the asset-side approach that we have been using, I do not think—and I feel this quite strongly— that it makes any sense for us to have or try to describe monetary policy with a single number, which is the size of the balance sheet or the size of our liabilities, as the Japanese did. There are a number of reasons for this, but the least important reason is probably just the fact that many of our programs don’t have fixed sizes. They are open-ended—like the swap programs, for example. Also, many of the programs have different timing, different durations, maturities, beginning points, ending points, and the like, and so in that respect I think it would be difficult to put in a single number. More important, the programs on the asset side of our balance sheet serve different purposes and have different structures, and aggregating a dollar of MBS purchase, a dollar of commercial paper purchase, and a dollar of swaps to make three dollars strikes me as being apples and oranges. I do not think that is the right way to think about it. Furthermore, and finally, these programs obviously have different operational costs and risks, different risks of losses, different maturities, and most important, they present different issues with respect to the exit strategy, which we will want to talk about. Rather than looking at this as a single number, as a measure of the liability side of the balance sheet, I think we ought to think about it as a portfolio of assets, a combination of things that we are doing on the asset side of our balance sheet, that have specific purposes and that may or may not be effective; but we can look at them individually.
Let me turn now quickly to the governance issues. Before getting into them, let me just say that, whatever difficulties we may have finding appropriate governance, it is certainly the case that the Federal Reserve Act did not exactly contemplate the situation in which we find ourselves today. I think we all agree that getting the right policies for the U.S. economy is the top priority and, whatever we do, we need to find a way to get the right policies in place. Frankly, I think the best way to achieve that—I am going to talk about some details—is through operating in good faith. If we work together and keep each other apprised of developments and our views, we will be able to make this work. If we take too narrow an approach, too legalistic an approach, I think it will be much more difficult.
So let me make a few comments. I think I can focus this best by simply answering the question: If the federal funds rate is at zero and the FOMC no longer sets the target, then what is the role of the FOMC in monetary policy? I have four answers to that question. The first is that the Federal Reserve’s outlook is the FOMC’s outlook. That is, the FOMC’s views about the evolution of the economy, of prices, and of financial conditions will govern our policy decisions. In particular, it is the FOMC’s outlook that appears in the minutes, it is the FOMC’s outlook that appears in the projections, and it is the FOMC’s outlook that appears in our communications. Therefore, if your board members ask you with respect to monetary policy, “Well, what are we doing now?” the answer is, “Keep telling us what you are seeing in the economy and financial markets. We will transmit that to the full FOMC because the FOMC’s outlook is the perspective that governs the policy actions that we take.”
The second role of the FOMC, I believe, is in the communication policy, both in the narrow and in the large. In the narrow, if we decide to adopt a target, make a commitment about the length of time in which we hold rates low, or make any other kind of verbal promise in our statements or in other contexts, that is obviously the FOMC’s prerogative, and I think we understand that that’s how it would work.
The third area is the most difficult one, and that has to do with the balance sheet. The law provides a kind of odd co-dependence, if you will, between the Board and the FOMC with respect to the balance sheet. Both the Board and the FOMC are enjoined by the Federal Reserve Act to pursue the dual mandate, and both the Board and the FOMC have powers that affect the size and composition of the balance sheet. In particular, the FOMC has authority over Treasuries, agency purchases, and swaps, whereas the Board has, in particular, the 13(3) authority, which has been utilized a lot lately for credit programs. So we have dual authority, and we have dual or joint responsibility. I think the only way to deal with that essentially is through close consultation and collaboration. My commitment to you is that we will work together even more closely, even more collegially, going forward to make sure that everyone is on board and understands what we are doing with respect to our various programs on the asset side of our balance sheet and that each person on this Committee is well informed and is able to give views and input into the discussions that we have.
The legal authorities are what they are, but I do think that a collective and cooperative effort can help us solve this problem. In particular, I understand that the briefing sessions that I have provided have been useful. I am willing to commit to do those as frequently as necessary, and I am willing to make them into meetings if we need to have two-way discussions and input from the Committee with respect to policy actions. So it is a bit awkward, but I hope that cooperation will allow us to work together on the balance sheet.
Now, there is a special issue here, though, which is the unwind issue. One way in which the balance sheet affects the responsibilities of the FOMC is that, if the FOMC is going to be raising interest rates at some point in the future, clearly, it needs to have information and understanding about the constraints being placed on policy by the size and composition of the balance sheet. So I think that keeping the FOMC as a whole informed about the balance sheet, about the programs, about the constraints that may be placed on the unwind, and about alternative strategies for raising rates once the time comes, is incumbent upon me and the rest of the Board to do. As a down payment on that, I have asked Bill Dudley, if there is time tomorrow, to give you a bit of an update on the TALF, the asset-backed securities loan facility, and talk to you about some issues that it raises for the unwind and for future interest rate policies.
Fourth, and finally, with respect to the FOMC responsibilities, is communication to the public. The public doesn’t make the distinction between the Board of Governors and the FOMC. The public understands the Federal Reserve. What we need to do is to come together and decide what policies we want to pursue and then collectively take responsibility for those policies and communicate them in a coherent and consistent way to the broad public. That is the responsibility of all of us, and I hope we can work together to provide everybody with the information that they need to do that effectively. In particular, I am going to say that, given the state of confidence in the markets and in the economy, I hope whatever disagreements we may have that as much as possible we can keep them within these walls. With respect to the public, we need, as much as possible, to communicate a clear strategy going forward.
So those are just some thoughts on governance. I recognize the problems. I am eager to hear your views about how to do it better. I am also interested in knowing how you think these governance issues should translate into the statements and into the directives. I think we have thrown out some suggestions there. We are not in any way wedded to them. If other people have other ideas, we are very open to adopting those ideas. But at least I want to say that I am fully aware of these issues, and I think that however many structures we may impose, nothing is going to substitute for a good faith, collaborative effort in making this work. Let me stop there and begin the go-round with President Lacker.