Failed Monetary Policy

Looking at economic output and demand, GDP fell 32% in the second quarter, but there is likely recovery from that historic low in the third quarter. On the business side, fixed investment looks very weak, but both manufacturing and non-manufacturing indicators are showing signs of improvement.

The role of central bank policy distorting incentives in 2019 was absent. Skewed investing incentives began on December 18, 2018 – when the FOMC statement misread the global economy and markets and balance sheet expansion resumed. I find that 30-minute changes in bond yields around scheduled Federal Open Market Committee announcements are predictable with the pre-FOMC Blue Chip professionals’ revisions in GDP growth forecasts. A positive pre-FOMC GDP growth revision predicts a contractionary policy news shock, a negative GDP growth revision predicts an expansionary policy news shock. Failing to account for this predictability biases the estimates of monetary policy effects on the economy. First, the Fed’s information effect dissipates as the truly unpredictable policy news shock does not affect professionals’ beliefs about the economy.

Let’s take a look at two specific economic conditions and what the Fed is likely to do. First, while there was a surge in news coverage about monetary policy around the time of the Chair’s speech, there was only a small increase in the number of respondents who reported having heard news about monetary policy; most people did not recall anything. This new language is a stronger statement than we have made in the past as we have struggled to effectively convey that the longer-run goal of 2 percent should not be interpreted as a ceiling. In the past, many of us on the FOMC have indicated that we would be comfortable with inflation running above 2 percent for a time after it has run low for some time – a type of opportunistic reinflation. The implication is that monetary policy will be somewhat more accommodative than in the past when inflation has been running persistently low in order to reach our longer-run inflation goal. These changes in the economic environment warranted asking ourselves whether there were revisions to our monetary policy strategy that would make it more effective in promoting our policy goals. And we made changes to our approach to both the inflation goal and the employment goal, which are summarized in our revised strategy statement.

Adjusting its asset purchase plan is among the more flexible tools the central bank can use as the virus situation worsens. Various credit facilities are set to expire on December 31, and renewal requires approval from Powell and Treasury Secretary Steven Mnuchin. With interest rates already sitting at their floor and new credit-facility policy subject to backlash from the Trump administration, asset purchases remain the least constrained tool in the Fed’s toolbox, Feroli said. The central bank has kept its policy stance intact for months after taking unprecedented steps to support the US recovery earlier in the year. The Federal Open Market Committee’s last meeting ended with policymakers keeping rates near zero and maintaining the same pace of asset purchases. Yet the weeks since have seen daily new COVID-19 cases hit multiple record highs and cities impose fresh restrictions. It uses monetary policy to influence the demand for goods and service in the economy.

We are delighted to share Jacques de Larosière’s latest thinking on “The Monetary Policy Challenge. ” Jacques thoughtfully evaluates the 2% inflation target so prevalent in advanced economy central banks today. His assessment is based on careful examination of structural determinants of inflation as well as distortions arising from equilibrium inflation consistently falling short of its target.

Monetary News

Second, net policy shock has a more negative impact on future actual GDP, than the raw policy shock. “While unconventional monetary policy supports the financial system in a crisis, it needs to be complemented by other prudential policies that ensure bank asset quality. These results, published in the Journal of International Money and Finance, confirm that, at least in the syndicated loan market, unconventional monetary policy doesn’t necessarily lead to increased risk-taking, which is good news for the Reserve Bank and policy-makers. They looked at the syndicated loan market, which is the market for large corporate loans, and the impact of unconventional monetary policy in the US after the global financial crisis in 2008. “I do not expect that the short term policy rate, the federal-funds rate is going to be increased until we’ve got inflation up to 2%.

This change elevates financial stability in the Fed’s hierarchy of goals and suggests that, depending on the circumstances, the Fed may consider tightening monetary policy in response to financial stability risks if other tools are inadequate. However, Brainard prioritized the use of regulatory policy over monetary policy to avoid instability. “It is vital to use macroprudential as well as standard prudential tools as the first line of defense in order to allow monetary policy to remain focused on achieving maximum employment and 2 percent average inflation, ” she said. Diving into economic outlook by examining the labor market, unemployment claims are elevated at record levels. However, the national unemployment rate is down from the initial peak, falling to 7. 9% in September.