FOMC participants were quite talkative last week, commenting on topics including Fed balance sheet policy, the role of policy rules in informing decisions on policy rates, and of course the economic outlook, including how they would approach normalizing rates in an environment of heightened fiscal policy uncertainty. Governor Tarullo also revealed publicly that he will soon leave the Board. This makes him the first governor to announce his departure since the election, though he said the election result did not affect his decision. We look forward to Chair Yellen’s semiannual monetary policy testimony in separate hearings taking place tomorrow and Wednesday. (See our Monetary Policy Testimony Preview.)
Policymaker Communications
Governor Tarullo announced his intention to retire in early April 2017. As we noted in a previous commentary, Tarullo took on the responsibilities of Vice Chair for Supervision in a de facto capacity. We had expected that Tarullo would likely leave if his supervision duties were passed on to another governor. (See also “Latest Developments on Future FOMC Composition.”) We suspected that Tarullo was one of the dots projecting two hikes in 2017. (See “Where’s Waldo? Naming the 2017 Dots.”) In an interview that was published following his letter of resignation, he revealed that he had decided in late 2016 to resign in early 2017, but he said that the election result was not a consideration. He saw the current Administration’s financial regulation principles as a “good starting point.” Earlier reports indicated that David Nason was a frontrunner for the Vice Chair for Supervision position. (See “Nason as Vice Chair for Supervision on the Fed Board?”)
Fiscal policy continued to be a key focus. Fischer underscored the “significant” uncertainty: “I don’t think anyone quite knows what’s going to come out of the process which involves both the administration and Congress in the deciding of fiscal policy and a variety of other things…At the moment we are going strictly according to what we see as our responsibility according to law.” Mester and Kashkari echoed Fischer’s view, with Mester noting “heightened uncertainty from the standpoint of our own policies.” She argued that the FOMC must “be willing to change our outlook based on changes in economic developments and also as there’s more clarity” on what fiscal policy changes will occur. Evans argued that it will “likely take some time” for any stimulus to affect growth, but also revealed that policymakers “have had to make a judgment about fiscal policies to some extent. There aren’t a lot of details.” Kashkari noted that “Financial markets are guessing about what fiscal and regulatory actions the new Congress and the Trump administration will enact. We don’t know what those will be, so I don’t think we should put too much weight on these recent market moves yet.” Bullard was unsure about the effect of a stronger dollar on the outlook, noting that perceptions of the effect are often “overblown.” Fiscal policy was one reason Bullard cited for not rushing into a March hike: “It is unlikely that fiscal uncertainty will be meaningfully resolved by the March meeting, which is only a few weeks away…we don’t have to move and we have got a lot of fiscal uncertainty, so why not wait until that gets resolved—or more clearly resolved?” He questioned the need for fiscal stimulus at this time—“The economy is not in recession today, so these policies should not be viewed as countercyclical measures…This is a source of great confusion”—but alluded to the potential impact on r-star: “policies may have some impact on the low-safe-real-rate regime if they are directed toward improving medium-term U.S. productivity growth.”
The primary focus of Fischer’s speech was the role of economic models and policy rules in monetary policy decisionmaking. He was skeptical that strict adherence to a policy rule would bring about the best decisions: “No one model or policy rule can capture the varied experiences and views brought to policymaking by a committee. All of these factors and more recommend against accepting the prescriptions of any one model or policy rule at face value.” He added, “A monetary rule, or a model simulation, or both, will likely be part of the economic case supporting a monetary policy decision, but they are rarely the full justification for the decision.” His comments were likely in part a reaction to legislative proposals to mandate that the Fed adhere to policy rules in making policy decisions. We noted that this would also be a focus of Congressional inquiry during Yellen’s testimony this week. (See our preview.)
Policymakers’ views continued to diverge on the outlook for labor market slack. Evans projected that the unemployment “is going to go down,” and is “still worried that inflation is a little bit too low, but it’s moving in the right direction.” As such, he called for a “slow” pace of normalization to provide a sufficient “buffer” against downside shocks. He also appeared concerned about downside risks that would compel a return to the zero lower bound. Mester argued that “we have essentially achieved our maximum employment goal from the standpoint of what monetary policy can achieve and we’ve made progress on the inflation goal,” while noting “I don’t believe we are behind the curve yet.” Bullard said “it does not appear that undue inflationary pressure is building,” concluding that “the policy rate can remain fairly low in 2017.” Kashkari observed that “the cost of labor isn’t showing signs of building inflationary pressures that are ready to take off and push inflation above the Fed’s target” and was skeptical of forecasts of high inflation because inflation globally is still low and the dollar could remain strong. He also noted that the U-6 unemployment rate suggests further running room. He was ambivalent between raising rates gradually sooner and waiting to move more aggressively later.
On balance sheet policy, the consensus still appeared to be evolving. Evans said “We need to be careful, deliberative, and use the best thinking of everybody we have in the Federal Reserve,” while Mester noted that “that’s an ongoing discussion that the Fed is having about what we want our longer run operating framework to be.” Bullard suggested that balance sheet normalization could be appropriate soon, citing the evolution of the yield curve: “Now that the policy rate has been increased, the FOMC may be in a better position to allow reinvestment to end or to otherwise reduce the size of the balance sheet…Ending balance sheet reinvestment may allow for a more natural adjustment of rates across the yield curve as normalization proceeds.” He emphasized the crucial role the balance sheet could play in future adverse scenarios: “I am hopeful we don’t get into these considerations, but those are the policy tools if we got into a recession in the near term.” He also noted that “you could allow some runoff in the balance sheet and it would probably go very smoothly so long as it was communicated appropriately.” He also argued that GSE reform could provide a reason to get MBS off the Fed’s balance sheet faster: “If there were to be GSE reform on the horizon and some people on Capitol Hill are talking as if GSE reform would be imminent, then we might not want to be holding MBS on the grounds that the successors to the GSEs are private sector companies and we’d be helping private-sector companies…If you took that kind of view it might bring more urgency to the issue of swapping MBS for Treasuries. But I don’t think we are to that point yet. This is just something that is in the discussion stage.” Evans floated the idea of selling assets outright or simply letting assets roll off: “We could sell assets. If we sold assets, then long-term interest rates would go up by even more…It might be enough just to let them mature.”