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EMBARGOED UNTIL WEDNESDAY, JANUARY 13, 2016 AT 8:20 A.M. EASTERN TIME OR UPON DELIVERY
Early Observations on Gradual
Monetary Policy Normalization
Eric S. Rosengren
President & CEO
Federal Reserve Bank of Boston
January 13, 2016
Greater Boston Chamber of Commerce
Boston, Massachusetts
bostonfed.org
Improvements in the U.S. Economy
▶ Recent employment report
▶ 292,000 jobs added in December
▶ 284,000 jobs added per month over the past
quarter
▶ Unemployment rate remained at 5 percent
▶ People previously not in the labor force are
entering the labor force
▶ Tighter labor markets have helped reduce
unemployment in some segments that still have
elevated unemployment rates
2
Not All Good News
▶ Weakness since the New Year
▶ Stock markets in much of the world began the year
on a decidedly weak note – particularly China
▶ Weak oil and commodity prices
▶ Analyst estimates of Q4 real GDP have been
declining
▶ Monetary policy should not overreact to shortterm, temporary fluctuations in financial markets
▶ But we do need to take seriously potential
downside risks to economic forecasts and
manage those risks as we think about the
appropriate path for monetary policy
3
Overview of My Comments Today
▶ The Fed raised short-term rates last month,
reflecting the significant progress of the U.S.
economy over the last year
▶ The initial monetary policy tightening was rather
uneventful
▶ The effective federal funds rate has largely traded
within the new target range
▶ Other short-term rates in the marketplace have moved
up as expected
▶ The future path of the federal funds rate will depend
on incoming economic data and likely be gradual
▶ I hope the improvement continues, so further
normalization is appropriate – but it is important to
carefully manage risks
4
The Beginning of Monetary Policy
Normalization
▶ Unemployment rate started 2015 at 5.7
percent and fell to 5.0 percent – 2.65 million
jobs created in 2015
▶ In December the FOMC raised the federal
funds target range: set a new target range of
0.25 to 0.50 percent
▶ The federal funds rate has tended to trade in
the market around 0.36 percent, about the
middle of the new target range
5
This Time is Somewhat Different
▶ Very high level of reserves in the banking system
(resulting from the Fed’s necessary, effective, but
extraordinary accommodation post-crisis)
▶ Core inflation has yet to show a clear movement
towards the Federal Reserve’s 2 percent target –
lack of significant inflationary pressures in the
U.S. and weakness in many parts of the world
▶ Real GDP is projected to grow only somewhat
faster than potential
▶ Monetary policy will likely move more gradually
than in past tightening cycles
6
Figure 1: Federal Reserve System Assets and
Excess Reserves of Depository Institutions in the U.S.
January 2000 - December 2015
5
Trillions of Dollars
4
Federal Reserve
System Assets
Excess Reserves
3
2
1
0
Jan-2000
Jan-2005
Jan-2010
Jan-2015
Recession
Source: Federal Reserve Board, NBER, Haver Analytics
7
Changes in Monetary Policy
Implementation
▶ Pre-crisis:
▶ Monetary policy set the federal funds rate, a
short-term interest rate on overnight loans
between banks
▶ Because the amount of reserves in the system
was relatively modest, small purchases and sales
by the Fed’s open market desk were sufficient to
alter the target (and actual) federal funds rate
▶ In response to the crisis:
▶ Fed lowered the federal funds rate to effectively
zero
▶ Deployed new policy tools – purchasing securities
8
Figure 2: Federal Reserve System Asset Composition
December 28, 2005 and December 30, 2015
5
Trillions of Dollars
Other Assets
4
Mortgage-Backed
Securities Maturing in
More Than 10 Years
Treasury Securities
Maturing in More Than 10
Years
3
Treasury Securities
Maturing in 5 to 10 Years
2
Treasury Securities
Maturing in 1 to 5 Years
1
Treasury Securities
Maturing in 1 Year or Less
0
December 28, 2005
December 30, 2015
Source: Federal Reserve Board, Haver Analytics
9
Figure 3: Excess Reserves of Depository Institutions
in the U.S. and the Federal Funds Rate
January 2000 - December 2015
4
Trillions of Dollars
Percent
8
Excess Reserves
(Left Scale)
3
Federal Funds Rate
(Right Scale)
6
2
4
1
2
0
Jan-2000
0
Jan-2005
Jan-2010
Jan-2015
Recession
Source: Federal Reserve Board, NBER, Haver Analytics
10
Post-Crisis:
▶ Large balance sheet, large supply of bank
reserves
▶ Usual way of raising the federal funds rate is
not available: no modest sale of securities will
remove enough excess reserves from the
system to tighten borrowing conditions in the
overnight federal funds market
▶ Need new tools to set the top and the bottom
of the federal funds target range
11
New Tool – Interest on Reserves
▶ Congress gave the Federal Reserve the authorization
to pay interest on reserves, effective October of 2008
▶ Banks receive interest on reserves held overnight with
the Federal Reserve
▶ An important tool as the Fed works to raise rates,
because banks will not want to lend at a rate below what
they can get from holding funds with the Fed
▶ Only banks hold reserves and can receive interest on
reserves
▶ Arbitrage plays a role – if overnight rates fall too far
below the interest on reserves, banks can make
money by buying overnight funds below the interest
on reserves and holding those funds at the Federal
Reserve where they earn the interest on reserves
12
New Tool – Reverse Repurchase
Agreement Rate
▶ Purchase funds from non-banks at a rate slightly
below interest on reserves
▶ Currently at a rate of 0.25 percent
▶ Collateralized, and transacted with the central
bank, so investors should be unwilling to lend
at a lesser rate
▶ Federal funds should trade in the range between
interest on reserves and the reverse repurchase
rate
13
Figure 4: Interest on Reserves, the FRB
Overnight Reverse Repurchase Rate, and the
Federal Funds Rate
December 1, 2015 - January 11, 2016
0.60
Percent
0.50
0.40
0.30
0.20
Interest Rate Paid on Reserves
0.10
Federal Funds Rate
ON Reverse Repurchase Rate
0.00
01-Dec-15
10-Dec-15
21-Dec-15
30-Dec-15
08-Jan-16
Note: Currently, the interest rate paid on required and excess reserves is the same.
Source: Federal Reserve Bank of New York, Federal Reserve Board, Haver Analytics
14
Figure 5: FRB Overnight Reverse Repurchase
Agreements: Total Amount Accepted
January 2, 2015 - January 11, 2016
500
Billions of Dollars
400
300
200
100
0
02-Jan-15
30-Mar-15
23-Jun-15
16-Sep-15
Note: Includes only fixed-rate, one-day reverse repurchase agreements.
Source: Federal Reserve Bank of New York, Haver Analytics
10-Dec-15
15
Figure 6: Selected Short-Term Interest Rates
December 1, 2015 - January 11, 2016
0.60
Percent
December 16th
0.50
0.40
0.30
0.20
0.10
1-Month Eurodollar Deposit Rate
1-Month LIBOR
1-Month AA Nonfinancial Commercial Paper Rate
0.00
01-Dec-15
10-Dec-15
21-Dec-15
30-Dec-15
08-Jan-16
Source: Federal Reserve Board, Intercontinental Exchange (ICE), Haver Analytics
16
Figure 7: Selected Long-Term Interest Rates
December 1, 2015 - January 11, 2016
5
Percent
December 16th
4
3
2
1
30-Year Fixed-Rate Mortgage Rate
48-Month New Car Loan Rate
10-Year Treasury Yield
0
01-Dec-15
10-Dec-15
21-Dec-15
Source: Federal Reserve Board, WSJ, Haver Analytics
30-Dec-15
08-Jan-16
17
Figure 8: Treasury Yield Curves
January 4, 2006 and January 4, 2016
6
Percent
5
4
3
2
January 4, 2006
1
January 4, 2016
0
0
1
2
3
4
5
6
7
8
9
10
Maturity in Years
Source: U.S. Department of the Treasury
18
FOMC Statement, December 16, 2015
▶ “The Committee expects that economic
conditions will evolve in a manner that will
warrant only gradual increases in the federal
funds rate.”
▶ “The Committee is maintaining its existing
policy of reinvesting principal payments from
its holdings… and it anticipates doing so until
normalization of the level of the federal funds
rate is well under way.”
19
Reinvestment Strategy
▶ Move short-term interest rates first, because
we have greater confidence in the likely effects
of such a move on the economy
▶ Desirable to have the flexibility to respond if
necessary to a large unexpected negative
shock by reducing short-term rates
▶ Reducing the size of our balance sheet would
be a form of tightening, with more impact on
longer-term rates
20
Figure 9: Unemployment Rate Projections of
Federal Reserve Governors and Federal Reserve
Bank Presidents, December 16, 2015
2015:Q4 - 2018:Q4
5.2
Percent
Central Tendency
5.1
Median
5.0
4.9
4.8
4.7
4.6
4.5
4.4
2015:Q4
2016:Q4
2017:Q4
2018:Q4
Note: The central tendency excludes the three highest and three lowest projections in each period.
Source: FOMC, Summary of Economic Projections (SEP), December 16, 2015
21
Figure 10: Civilian Unemployment Rate and
the Natural Rate of Long-Term Unemployment
1960:Q1 - 2015:Q4
12
Percent
9
6
3
Natural Rate of Long-Term Unemployment
Civilian Unemployment Rate (U-3)
0
1960:Q1
1969:Q1
1978:Q1
1987:Q1
1996:Q1
2005:Q1
2014:Q1
Recession
Source: BLS, CBO, NBER, Haver Analytics
22
Figure 11: U.S. Inflation Rate: Change in Core
Personal Consumption Expenditures Price Index
January 1994 - November 2015
3
Percent Change from Year Earlier
2% Inflation
Target
2
1
0
Jan-1994
Jan-1999
Jan-2004
Jan-2009
Jan-2014
Recession
Source: BEA, NBER, Haver Analytics
23
Figure 12: Core Inflation Rate Projections of
Federal Reserve Governors and Federal Reserve
Bank Presidents, December 16, 2015
2015:Q4 - 2018:Q4
2.5
Percent Change from Year Earlier
2.0
1.5
1.0
Central Tendency
0.5
Median
0.0
2015:Q4
2016:Q4
2017:Q4
2018:Q4
Note: The central tendency excludes the three highest and three lowest projections in each period.
Source: FOMC, Summary of Economic Projections (SEP), December 16, 2015
24
Figure 13: U.S. Federal Funds Rate Projections of
Federal Reserve Governors and Federal Reserve
Bank Presidents, December 16, 2015
December 31, 2015 - December 31, 2018
4.5
Percent
Median Observation
4.0
3.5
3.0
2.5
2.0
1.5
1.0
0.5
0.0
Year-end 2015
Year-end 2016
Year-end 2017
Year-end 2018
Source: FOMC, Summary of Economic Projections (SEP), December 16, 2015
25
Concluding Observations
▶ The initial increase in short-term rates was
rather uneventful
▶ The Federal Reserve’s target rate moved as
expected
▶ Other short-term rates have moved as expected
▶ Further increases in rates are in my view likely
to be gradual
▶ I remain highly attentive to foreign economic
conditions, any weakening of the domestic
economic situation, and the path of U.S. inflation
26