Michelle W Bowman: The Federal Reserve's balance sheet as a monetary policy tool - past lessons and future considerations
Speech by Ms Michelle W Bowman, Member of the Board of Governors of the Federal Reserve System, at the 2024 BOJ-IMES Conference "Price Dynamics and Monetary Policy Challenges: Lessons Learned and Going Forward", hosted by the Institute for Monetary and Economic Studies, Tokyo, 28 May 2024.
The views expressed in this speech are those of the speaker and not the view of the BIS.
I would like to thank the Bank of Japan and Governor Ueda for organizing this year's conference and for the invitation to participate in this afternoon's panel. The topic of "the effects of conventional and unconventional policy instruments" is an important one given central banks' expanded use of unconventional monetary policy tools to pursue their mandates over the past decade and a half.
My remarks focus on the use of the central bank balance sheet as a monetary policy tool. I will first offer some observations regarding the benefits and costs of large-scale asset purchases (LSAPs) by reflecting on the two episodes of the Federal Reserve's active use of the balance sheet in U.S. monetary policy following the 2008 financial crisis and during the COVID-19 pandemic. I will then discuss some considerations regarding future balance sheet policy as the Federal Open Market Committee (FOMC) seeks to bring inflation back down to its 2 percent target following the post-pandemic inflation surge, and as the FOMC continues to reduce the size of the Federal Reserve's balance sheet.
Lessons Learned from Past Uses of the Federal Reserve's Balance Sheet as a Monetary Policy Tool
Post-2008 financial crisis balance sheet policy
A key challenge for the FOMC following the 2008 financial crisis was how to provide additional support to an economy that was experiencing high unemployment and subdued inflation after the FOMC lowered its primary and conventional monetary policy tool-the target range for the federal funds rate-to near zero. Given the importance of longer-term interest rates for broader asset prices and for investment and consumption decisions, the FOMC used both forward guidance and LSAPs to help lower longer-term rates, which had not yet moved to zero. The intent of forward guidance was to lower longer-term interest rates by shifting expectations of "low-for-long" short-term interest rates in line with a low-for-long federal funds rate. LSAPs, or quantitative easing (QE), were intended to reduce longer-term interest rates further by lowering the yields of specific longer-dated securities being purchased and by reducing more generally the term premia, the compensation that investors must earn to incentivize investment in a longer-term bond relative to a short-term bond. LSAPs could also reinforce the FOMC's forward guidance of low-for-long short-term interest rates. Such reinforcement of low-for-long forward guidance could be especially powerful if the FOMC communicated that it would not consider raising the target range for the federal funds rate until it stopped actively engaging in asset purchases for the purposes of QE.