(The opinions expressed here are those of the author, a
columnist for Reuters)
By James Saft
Feb 23 U.S. interest rates will rise but the
future of monetary policy may look a lot more like the present
than the pre-crisis past.
Not only has the world changed, but the occupant of the
White House has changed, and that will change, perhaps
substantially, the lineup and outlook of the Federal Reserve.
After the Fed has tightened two or perhaps three times this
year, its ability and will to continue to hike, or to shrink its
massive balance sheet will be materially constrained.
The minutes of the January rate-setting meeting, released
Wednesday, gave the impression that a March hike was in play
more as a matter of form than reality. What’s more there was
little by way of discussion about the $4.5 trillion balance
sheet of bonds the Fed purchased to influence the level of
interest rates, credit availability and longer-term financing
“It was noted that the downward pressure on longer-term
interest rates exerted by the Federal Reserve’s asset holdings
was expected to diminish in the years ahead in light of an
anticipated gradual reduction in the size and duration of the
Federal Reserve’s balance sheet,” the minutes said.
“Finally, the view that gradual increases in the federal
funds rate were likely to be appropriate also reflected the
assessment that the neutral real rate - defined as the real
interest rate that is neither expansionary nor contractionary
when the economy is operating at or near its potential - was
currently quite low and was likely to rise only slowly over
In other words, we don’t really want to talk about how we
will run the balance sheet down any time soon and it kind of
doesn’t matter anyway. The Fed needn’t be in a hurry to bring
its balance sheet down to pre-crisis norms, but were it to be,
it might be in a fix anyway.
San Francisco Fed President John Williams, who has become
something of a structural dove, argues that the equilibrium
interest rate, r-star, the rate at which the economy is in
balance between growth and inflation, has fallen, making it
harder to manage the economy, and harder to avoid financial
“In a low r-star world, what were once called
‘extraordinary’ policies - like zero or negative interest rates,
forward guidance, and balance sheet policies - are likely to
become the norm,” Williams wrote in a Tuesday note.
LIVING IN A TRUMP WORLD
Williams’ analysis cuts both ways: it will be harder to get
rates back to historic norms and lighten the balance sheet, but
doing so may have disproportionate utility, as it gives the Fed
ammunition with which to fight the next downturn in the cycle.
With the upcoming resignation of Daniel Tarullo, Trump will
have three appointments to make to the Fed’s board of governors.
He will also get to appoint the chair sometime in the next year,
either retaining Janet Yellen or replacing her. If Yellen is
replaced as chair but elects not to remain on the board, an
option at her disposal, Trump would get another slot. Fed Vice
Chair Stanley Fischer might also head for the door.
While Trump campaigned “against” easy Fed policy, in
somewhat the same way he campaigned against the press, now that
he can, via appointments, influence it you can expect he will
and that appointees will see the wisdom of keeping the financing
costs of the Trump experiment lower rather than higher.
That’s not to say Trump Fed appointees won’t fight inflation
- they will - but given that there are strong arguments for
keeping rates low and the balance sheet large, you can see how
he would find candidates who find these arguments compelling.
Allowing bonds to mature is a tightening; Yellen has
estimated that allowing the $177 billion of maturing Treasuries
this year to run off would be about the same as raising rates by
a half a percentage point.
Noting that $425 billion of Treasuries mature next year and
another $350 billion or so do in 2019, Marc Chandler of Brown
Brothers Harriman argues that “the tightening will swamp the use
of the fed funds target range as the primary tool of monetary
Extraordinary monetary policy may only become slightly less
(Editing by James Dalgleish)