One question to ask is whether the guidance we issued was too "restrictive"; in other words, did it allow enough flexibility for the FOMC to begin raising the policy rate when it was appropriate to? Recall, we had decided that raising the policy rate would not occur until the tapering of asset purchases had finished. But to finish, tapering must start — for a given pace of tapering, the longer it takes to start tapering, the longer it will be before the policy rate can be raised. Of course, one can keep the liftoff date fixed and simply taper at a much faster rate, including the possibility of a hard stop of asset purchases. But concerns about financial market functioning, including the ability of markets to absorb the purchases the Fed stops making, typically limits how fast the tapering can be, particularly given the amount of asset purchases we were making at the time ($120 billion per month).
Given the tapering criteria and subsequent data, we ultimately had to pivot hard to accelerate the tapering pace and, in fact, completed the tapering of purchases just a few days before we lifted off. Unlike the normalization timeline after the financial crisis, we did not have flexibility to raise the target range sooner. However, if we had less restrictive tapering criteria and had started tapering sooner, the Committee could have had more flexibility on when to begin raising rates.6 So, by requiring substantial further progress toward maximum employment to even begin the process of tightening policy, one might argue that it locked the Committee into holding the policy rate at the zero lower bound longer than was optimal.
My takeaway is that a less restrictive tapering criteria would have allowed more flexibility to taper "sooner and gradually,' as opposed to the relatively "later and faster" approach that occurred. Experience has shown that markets need time to adjust to a turn from accommodation to tightening, and that surely was a factor for FOMC statements over the years in framing criteria for key policy actions during the recovery from the GFC and the pandemic. So, I'm supportive of issuing such criteria but we need to be careful to use language that allows the Committee the flexibility it needs to respond to changing economic and financial conditions.
Now let's turn to the liftoff criteria. It was also quite restrictive. The liftoff criteria required the economy to be in a situation where our dual mandate had been achieved. It can be argued that this meant getting the economy back to its 2019 state with very low unemployment and inflation near 2 percent. But the policy rate in 2019 was well above zero and close to its neutral value. Consequently, if the state of the economy is telling you to be at neutral and you are at zero, then any Taylor rule would say the policy rate needs to rise much faster than was typically done in the past.
So, it should not have been a surprise that the policy rate would rise fast in 2022. Rate hikes would need to be larger and more frequent, relative to the 2015-2018 tightening pace, to get back to neutral. Looking back, should the Committee have signaled a steeper rate path once the liftoff criteria had been met? Perhaps another lesson is that giving forward guidance about liftoff should also include forward guidance about the possible path of the policy rate after liftoff.
In closing, I hope that our country is not faced with another crisis as severe as the one precipitated by COVID, and that the Fed is not faced with the challenges of setting monetary policy under such conditions. But if we again face those challenges, we now have the additional insight that only experience can bring. I hope that this latest experience will help us approach the future with a more complete understanding of the policy choices and tradeoffs.
1. See Christopher J. Waller (2022), "Reflections on Monetary Policy in 2021," speech delivered at the 2022 Hoover Institution Monetary Conference, Stanford, California, May 6; and Christopher J. Waller (2021), "A Hopeless and Imperative Endeavor: Lessons from the Pandemic for Economic Forecasters," speech delivered at the Forecasters Club of New York, New York, December 17. These remarks represent my own views and not any position of the Federal Reserve Board or the Federal Open Market Committee. Return to text
2. Research has suggested a large number of developments may have contributed to a decline in the equilibrium real interest rate, focusing on factors that may have shifted aggregate savings and/or investment in a manner that depresses the real interest rate required to equilibrate savings and investment. For example, lower trend economic growth likely lowers aggregate investment, while demographic factors such as an increase in life expectancy may increase savings. Other research has emphasized an increase in demand for safe assets among emerging market economies, which depresses interest rates in advanced economies. For a review and references, see Michael Kiley (2020), "The Global Equilibrium Real Interest Rate: Concepts, Estimates, and Challenges," Annual Review of Financial Economics, vol. 12 (1), pp. 305–26. Return to text
3. Supported by funds provided by the CARES Act, the Federal Reserve created, with the authorization of the U.S. Treasury Department, a number of emergency lending facilities. The extraordinary 'dash for cash' early in the pandemic threatened the orderly functioning of money markets as well as the flow of credit to employers. The Board responded with a set of emergency lending facilities that, collectively supported the flow of credit throughout the economy both by providing backstops and, in some cases, by more directly supplying funding. Future downturns are unlikely to see the same global, sharp, and intense demand for liquidity, and thus not warrant the same kind of emergency lending. For more details on the Fed's facilities to support households, businesses, and municipalities during the COVID crisis see the November 2020 Financial Stability Report. Return to text
4. See Board of Governors of the Federal Reserve System (2021), "Federal Reserve Issues FOMC Statement," press release, June 16, Return to text
5. This phrase echoed a new detail in our monetary policy strategy that recognized the 12 years that inflation had run persistently below 2 percent and noted that as a result, "appropriate monetary policy will likely aim to achieve inflation moderately above 2 percent for some time." See Board of Governors of the Federal Reserve System (2020), "2020 Statement on Longer-Run Goals and Monetary Policy Strategy," policy statement, August 27. Return to text
6. There are a couple of reasons why a less restrictive tapering criteria can create more policy space. First, a less restrictive tapering criteria allows policymakers to reduce the amount of purchases, perhaps more than once or even potentially end purchases, all while a more restrictive criteria may not even be triggered. Second, if policymakers believe that market functioning considerations constrain the dollar amount that Fed purchases can be reduced in a given month, then a policy with less restrictive criteria that has started tapering may be able to end purchases before one with a more restrictive criteria. Return to text
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