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A new report punches holes in the theory that Federal Reserve crisis-era asset purchases kept down long-term interest rates and says the use of interest rate policy is more effective.
This was the conclusion of a paper presented Friday by Wall Street and academic economists at the U.S. Monetary Policy Forum. The gathering, dubbed the "Jackson Hole of the East" by one strategist, is an annual conference sponsored by the University of Chicago Booth School of Business and brings together Wall Street and academic economists, as well as Fed officials.
The paper said the consensus view that the Fed's quantitative easing lowered 10-year Treasury yields by 1 percentage point (100 basis points) was overstated, and that Fed asset purchases did not have as much impact on long Treasury yields as generally believed.
The authors studied news reports and market activity and concluded that Fed actions and announcements were not really the dominant determinant of 10-year yields, as the impact was temporary.
New York Fed President William Dudley and Boston Fed President Eric Rosengren were part of a panel discussing the paper.
Dudley, in prepared remarks, countered the findings, saying the Fed's use of long-term asset purchases was important, particularly when the Fed was holding short-term interest rates at zero. He said the purchases may have resulted in less impact on yields than some studies had suggested but the programs also made forward guidance from the Fed more credible. He added the paper's findings do not suggest the Fed should not use the asset purchases when rates are at zero.
"The paper's findings do not, in my mind, invalidate the use of LSAPs [large-scale asset purchases] when the Federal Reserve is operating at or close to the zero lower bound for short-term interest rates. That is the key issue—not the magnitude of the effects of LSAPs or whether short-term interest rates should be the primary tool of monetary policy," Dudley said in the statement.
The authors include Morgan Stanley senior desk economist David Greenlaw and Bank of America Merrill Lynch's head of global economic research, Ethan Harris. Kenneth West, University of Wisconsin economics professor, and James Hamilton, University of California economist, were also authors.
"Going forward, we expect the Federal Reserve's balance sheet to stay large," they wrote. "Our conclusion is that the most important and reliable instrument of monetary policy is the short- term interest rate."
The authors said the size of the Fed 's balance sheet is less powerful in moving the bond market than perceived and should not be used as a primary policy tool in the future. The Fed late last year began the process of unwinding its more than $4 trillion balance sheet by tapering back on purchases it makes to replace maturing securities.
The Fed should hold a small amount of mortgage securities to signal that purchases of those securities are still a possibility. But it should hold mostly short-term Treasurys, the report said. The Fed is currently reducing its purchases by $20 billion a month and will gradually increase that amount. The central bank is expected to allow a runoff by about $180 billion this year alone.
"The Fed should consider larger and looser caps on the amount of redemptions," they wrote.