June 4, 2019
By Howard Schneider and Ann Saphir
CHICAGO (Reuters) – Resigned to holding trillions of dollars in bonds and buying yet more to fight future downturns, Federal Reserve officials are debating how to design future asset purchases to be as effective as possible in steering markets and holding down interest rates.
The next time their benchmark lending rate hits zero, as it did a decade ago, should they follow rapidly with, say, $5 trillion of bond buying? What about a set of rules for when a purchase program kicks in? Or should they promise beforehand to buy however much is needed to keep long-term interest rates at a targeted level?
These questions are front and center to a two-day Chicago Fed conference on the central bank’s strategy that kicked off on Tuesday. The answers could prove critical in determining how the Fed next deploys its virtually limitless power to buy assets, a strategy designed to bring down the long-term interest rates that shape household spending and business investment.
St. Louis Fed President James Bullard said he thought the three rounds of “quantitative easing” carried out in response to the 2007 to 2009 crisis resulted in “a lot of learning” on the part of policymakers and investors who may now react more quickly to Fed bond purchases.
“When we go back to the ZLB at some point it will all be different,” he said, and perhaps allow the Fed to achieve stronger results while buying less, Bullard said. “ZLB” refers to the “zero lower bound” for interest rates at which the Fed would need to resort to other tools to bolster the economy besides cutting short-term borrowing costs.
Others suggested the Fed may need to buy even more than the $3.5 trillion purchased over several years last time, relying on a “stronger, sooner” strategy to shock markets, or to set explicit rules about how and when “quantitative easing” would be used so investors would know what to expect.
“Some of these rules, putting in maturities — actually pinning down a level of rates, might be a practical way,” to manage future QE programs, said Jonathan Wright, a Johns Hopkins University professor and co-author of one of the central papers under discussion in Chicago. The idea is similar to the strategy of “yield curve control” currently used by the Bank of Japan and raised recently by top Fed officials as a tool worth at least studying for the United States.
Whatever direction is followed, Fed chairman Jerome Powell made clear in opening remarks he feels the once-novel strategies rolled out during the crisis are likely here to stay. The Fed’s target interest rate, currently in a range of just 2.25% to 2.5%, will probably remain lower than it has in recent decades, with the central bank likely to hit its zero limit again and face the question of what to do next, he said.
“There will be a next time,” Powell said, contending that while programs like Fed asset purchases were controversial at the time, he feels they worked and should no longer be viewed as “unconventional.”
“These policies provided meaningful support…We know that tools like these are likely to be needed in some form,” in future downturns, Powell said. It was the Fed’s “obligation,” he added, to outline its plans ahead of time so the public and elected officials know what the central bank intends to do.
NOT THE SAME QE
There will be new constraints.
The Fed in its three earlier quantitative easing programs primarily bought U.S. Treasury bonds – something it had always done, though in much smaller quantities before the crisis – but also purchased mortgage-backed securities in a more-targeted effort to bolster the failing housing market.
The bond market today is about twice the size as it was then, perhaps forcing the Fed to entertain much larger purchases than before.
And the next crisis may be of a nature that requires a different strategy depending on what markets are stressed and in what ways, a barrier to announcing too much ahead of time, said Janice Eberly, a Northwestern University professor who collaborated with Wright and Harvard professor James Stock on research for the conference.
The aim, she said, should still be “stronger policy…much earlier in the recession.”
In research based on how markets reacted to crisis-era programs, Eberly said the best results came when the Fed moved “immediately…a very large move early brings down the unemployment rate.”
Not all are sold on the benefits of QE. Stanford University professor John Taylor said he regarded the evidence as “quite weak” that Fed bond purchases had much lasting impact on long-term interest rates.
But the focus of discussion here was less on litigating what happened a decade ago than on planning how future bond buying may be made more effective.
The Fed could “take steps to encourage markets to understand policies and get them priced in earlier,” said Brian Sack, who as executive vice president at the New York Fed was deeply involved in carrying out the earlier easing programs. “Talking more about the policy rules…is appropriate” to guide future bond purchase programs and improve their impact.
(Reporting by Howard Schneider; Editing by Dan Burns and Andrea Ricci)