Tuesday, January 11, 2011

Federal Reserve Open Market Committee (FOMC) for 2011

Each January there is turnover of at least four of the eleven seats on the Federal Reserve Open Market Committee (FOMC). The Board of Governors of the Federal Reserve System is responsible for the discount rate and reserve requirements, and the Federal Open Market Committee is responsible for open market operations. Here is a link to a previous post with some additional background on the FOMC and the nine 2010 members.

The new members for 2011 will be presidents from four of the 12 Regional Bank Branches. The four Branches are in Chicago, Philadelphia, Dallas and Minneapolis. In addition, Janet Yellen, President of the San Francisco Branch, and Sarah Bloom Raskin, formerly the Commissioner of Financial Regulation for the State of Maryland, (the state ranks #12 as of 12/31/2010 on the unofficial problem bank list) were each appointed Governor's on The Fed Board last October, making them long-term members. In Yellen's appointment her vote is retained past 2010 because her Branch moves to the non-voting alternate member list for the 2011 term. Non-voting Reserve Bank presidents attend the meetings of the Committee, participate in the discussions, and contribute to the Committee's assessment of the economy and policy options.

Below is a look at representative quotes from speeches made recently by each ot the new members. Bloom Raskin has given only one speech as a board member. These might provide helpful background when the time comes to speculate about whether the program of quantittative easing gets extended. The current program is scheduled to stop by the end of June 2011.

The speech by Kocherlakota is given to an audience of college students and so he talked in terms that more people can understand. Many of the other speeches are weighted with econo jargon. Never-the-less, a quick browse will be enlightening for understanding more about the Fed's practices and plans for managing through the policy challenges that the economies of the world are faced with.

  • Evans: "These are the classic symptoms associated with a liquidity trap: the supply of savings that outstrip the demand for investment even when short-term nominal rates are at zero.
    The modern economic theory of liquidity traps indicates that the optimal policy response at zero-bound is to lower the real interest rate, almost surely by employing unconventional policy tools. Theory also indicates that, in the absence of such policy stimulus, the factors that generate high risk aversion could very well stifle a meaningful recovery, keep unemployment high and reinforce disinflationary pressures – clearly an undesirable equilibrium."

  • Fisher: "The remedy for what ails the economy is, in my view, in the hands of the fiscal and regulatory authorities, not the Fed. I could not state with conviction that purchasing another several hundred billion dollars of Treasuries—on top of the amount we were already committed to buy in order to compensate for the run-off in our $1.25 trillion portfolio of mortgage-backed securities—would lead to job creation and final-demand-spurring behavior. But I could envision such action would lead to a declining dollar, encourage further speculation, provoke commodity hoarding, accelerate the transfer of wealth from the deliberate saver and the unfortunate, and possibly place at risk the stature and independence of the Fed."
  • Kocherlakota: "As I mentioned before, I do not currently vote on FOMC decisions. I did express support for the FOMC’s decision at the recent meeting. I believe that QE is a move in the right direction. However, as I have discussed on earlier occasions, I also think there are good reasons to suspect that the ultimate effects of any amount of QE are likely to be relatively modest. That’s why I would have greatly preferred for the committee to have been able to cut its target rate rather than using QE. The problem is that its target rate is already essentially at zero, and so it was not possible to cut the target rate any further."
  • Plosser: "I would not advocate raising interest rates simply to lower asset prices when they appear to deviate from fundamentals. This is a policy that is easy to get wrong and fraught with risks. Moreover, policy directed to influence asset prices could encourage discretionary actions by the Fed that would draw it ever deeper into credit allocations and the determination of relative prices. That should not be the role of monetary policy."
  • Yellen: "However, given the moderate exchange rate effects that we believe the Federal Reserve's asset purchases have had, it seems likely to me that, as seems to be the case with conventional monetary easing achieved by lowering interest rates, our decision to purchase assets will not hinder foreign growth. In particular, given the importance of the United States in the global economy, it is hard to believe that any foreign country would gain if our economy were to fall back into another recession. Over the longer term, the health and vitality of the global economy will depend importantly on the sustained, vigorous recovery in the United States that our asset purchase program is intended to support."
  • Bloom Raskin: "So the problems that have been grabbing headlines in recent weeks are neither new nor amenable to quick fixes. While there may be some specific practices--"robo-signing" among them--that are possible to isolate and eliminate, chronic, uncured problems continue to plague this industry. There is a long track record of actions and cases brought by attorneys general, which some of you in this room have no doubt litigated, demonstrating the harm done to consumers by sloppy or unscrupulous practices. Because consumers cannot choose to hire or fire their servicers (other than by paying off the loan), the industry lacks the level of market discipline imposed in other industries by the working of consumer choice. For this reason, if servicers do not actively maintain adequate and trained staff and do not establish and heed internal controls, if investors do not monitor their servicers' behavior, if regulators do not conduct meaningful examinations, if courts do not stand guard against unfair practices, both substantive and procedural, then it will be much less likely that a well-functioning housing market will reemerge from this crisis. Because the very structure of the loan servicing industry as it currently operates inevitably leads to misaligned incentives and a propensity to defer costly investments, a more significant re-thinking of the basic business model must also be undertaken if we are to avoid repeating prior mistakes."
 One of the observations drawn from all of these speeches is how the Fed monitors inflation. Specifically, they use PCE (personal consumption expenditures) rather than CPI. Food and energy are completely discounted in PCE too, because they are considered volatile for the purpose of monitoring inflation (WTF?).

In Janet Yellen's speech, she offers some clarity about the FOMC tools and timing for withdrawal of the monetary stimulus... "We recognize that the FOMC must withdraw monetary stimulus once the recovery has taken hold and the economy is improving at a healthy pace. Importantly, the Committee remains unwaveringly committed to price stability and does not seek inflation above the level of 2 percent or a bit less than that, which most FOMC participants see as consistent with the Federal Reserve's mandate.
In contrast, I disagree with the notion that the large quantity of reserves resulting from our asset purchases poses some special barrier to removing policy stimulus when the right time comes. The FOMC will be able to increase short-term rates by raising the interest rate that we pay on excess reserves--currently 1/4 percent. That ability will allow us to manage short-term interest rates effectively and thus to tighten policy when needed, even if bank reserves remain high.
Given the very high level of reserve balances, changes in the interest rate on reserves might not be fully reflected in the federal funds rate and other short-term market rates. In that event, the Federal Reserve can use tools it has developed and tested to drain or immobilize bank reserves, thereby enhancing our control over the federal funds rate. To build the capability to drain large quantities of reserves, the Federal Reserve has expanded the range of its counterparties for reverse repurchase operations beyond the primary dealers and has developed the infrastructure necessary to use agency MBS as collateral in such transactions. The Federal Reserve has also put in place a Term Deposit Facility through which it can offer deposits to member institutions that are roughly analogous to the certificates of deposit that these institutions offer to their customers. We have tested both of these tools by conducting several small-scale operations and have the ability to initiate them quickly if needed. The use of reverse repurchase operations and the Term Deposit Facility would allow the Federal Reserve to drain hundreds of billions of dollars of reserves from the banking system should conditions necessitate. We don't think that draining such large amounts of reserves will be necessary for a smooth exit, but it makes sense to be prepared, and hence we have followed this "belt and suspenders" approach.
Finally, we can sell portions of our holdings of MBS, agency debt, and Treasury securities if we determine that doing so is an appropriate way of tightening financial conditions when the time comes. The redemption or sale of securities would have the effect of reducing the size of the Federal Reserve's balance sheet as well as further reducing the quantity of reserves in the banking system. Restoring the size and composition of the balance sheet to a more normal configuration is a longer-term objective of our policies. Any such sales would be at a gradual pace, would be clearly communicated to market participants, and would entail appropriate consideration of economic conditions.
In short, the range of tools we have developed will permit us to raise short-term interest rates and drain large volumes of reserves when it becomes necessary to achieve the policy stance that fosters our macroeconomic objectives--including the objective of maintaining price stability."

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