Fed mulls promises for the future, appears to discount yield curve control
The Federal Reserve edged towards a longer-range plan for monetary policy at its meeting last month, raising serious questions about a strategy known as yield curve control that is untested in the United States, and signaling it may rely on explicit promises about its inflation or employment goals to steer public expectations.
Minutes from the U.S. central bank’s June 9-10 meeting indicate policymakers held a lengthy debate about the critical next steps they may take in setting monetary policy for what they hope will be a continued recovery from a pandemic-driven health and economic crisis.
At the center of discussion: whether to import the sort of long-term interest rate targeting currently used by the Bank of Japan (BOJ) and the Reserve Bank of Australia (RBA), and what statements or “forward guidance” to make in the coming months about its plans for the recovery period.
While no decisions were made, policymakers appeared skeptical of yield curve control, alternately described as a “target” or “cap” in the Fed’s minutes, which were released on Wednesday.
“Nearly all participants indicated they had many questions regarding the costs and benefits of such an approach,” the minutes said. They then offered a long list of possible problems, from the Fed losing control of the size of its balance sheet to defend a rate target, to losing control of its independence if, for example, other monetary policy goals like controlling inflation clashed with the rate target.
Fed officials did appear to favor crafting some promises about the future – in effect making a pledge not to raise rates until some goal is met, with some of them favoring a focus on inflation and others on the unemployment rate.
That sort of language, many Fed officials felt, could stand on its own, “as long as the (policy-setting) committee’s forward guidance remained credible,” and would not need to be combined with yield curve control, as is currently done by the RBA.
In a recent poll, 29 of 44 economists said they did not think the Fed would introduce yield curve control this year. Goldman Sachs analysts gave slightly better than even odds the Fed might incorporate some element of yield curve control into its longer-range plans for managing the economic fallout from the novel coronavirus outbreak.
“The most likely next step” is for the Fed to tie future rate hikes to achievement of its long-elusive 2% inflation goal, JP Morgan analyst Michael Feroli said after the release of the minutes.
The behavior of global bond markets isn’t forcing the Fed to rush. Interest rates across the spectrum are at record lows: Even if the U.S. central bank decided to target some long-term rate, it likely wouldn’t set it at lower level than the rates already produced by a gloomy global economic outlook.
That is giving Fed officials time to continue studying the issue and watching how different rate-control strategies are playing out among their peers.
While much of the attention has focused on the BOJ’s decision to set an interest rate on the 10-year bond, a more likely parallel for the United States is the RBA’s recent move to set a 0.25% rate on the three-year government bond.
The RBA has not just specified the target for that bond, but promised to maintain it “until progress is being made towards the Bank’s goals of full employment and the inflation target.”
That sort of combination strategy – of tying explicit promises about interest rates to progress on a central bank’s mandated goals – has been mentioned favorably by some officials in an ongoing review of Fed monetary policy.
Fed Governor Lael Brainard in a pair of speeches last year outlined strategies roughly similar to what the RBA adopted in March, in which interest rates were capped over perhaps a one-year or two-year horizon – with the time frame tied to how long policymakers judged it would take to see the hoped-for changes in unemployment and inflation.
But there are risks. The Fed used yield curve control during and after World War Two to hold down long-term interest rates to help finance the war effort. That required close cooperation with the U.S. Treasury, and central bankers found it hard later to break that connection and reassert enough independence to control rising inflation – a dynamic revisited at the Fed’s meeting last month.
“It seems like there’s slightly less urgency (in June’s minutes) than I would have expected. And I’m glad to see some members concerned about the financial stability consequences,” said Jon Hill, U.S. rates strategist at BMO Capital Markets.
Nonetheless, Hill said he thinks the Fed could still launch a yield curve control effort, but he believes the next few meetings are off the table to allow it to study the issue more extensively. “It’s more of a Q4 story,” Hill said.