The Translation of Monetary Policies into Monetary Conditions In this issue of Monetary Mechanics, I discuss in detail the differences between the Federal Reserve’s intended monetary policy stance and actual monetary conditions in the real and financial economy. Although many people believe that the Federal Reserve’s monetary policies are automatically and perfectly transmitted through the real and financial economy, working as they are originally designed to do, I believe that that is not the case. In previous issues of
Interesting piece. I would venture that policy changes since the GFC have likely tightened the link between policy and conditions. But this may unravel. Also if ‘Liquidity’ is in some sense a measure of the b/s capacity of financial intermediaries, it may be worth considering what drives each side of the financial sector b/s and whether assets or liabilities are exogenous or endogenous factors…. or both?
I can share with you some other research I've done, but basically I would argue that (at least in the US) the link between policy and conditions since the ~1970s or so was extremely fragile and dependent primarily on expectations management and for banks to behave in an appropriate manner to policy changes. Essentially, I believe that there was no "hard" mechanism of policy transmission, policy transmission relied on the assumption that the Fed could influence incentives to conduct balance sheet expanding interest rate arbitrage (maturity transformation, but also others) because reserves were supposed to be central.
Quantity/price of reserves may have been exogenous from the banks' perspectives, but after liability management was let out of the bag (and later market-based finance) the Fed totally lost any control over the ability to actually influence interest rate conditions and the system just worked like a bit of a magic trick (if you act in a manner that is consistent with "easing" then policy will have the effect of easing even if there is no "real" transmission mechanism aside from psychological influence). Moves by the Fed post-GFC imply that they understand this (somewhat) and attempting to rectify the decision (IOER, RRP, SRF, LIBOR --> SOFR, etc.).
I'd argue that money is far more endogenous (on both sides) than it is exogenous, and that the most important exogenous restraints today are regulatory in nature (LCR, SLR, etc.).
Thanks. I would agree with all these sentiments. The key change to the financing system has been the switch in sources of funding from the domestic retail depositor to the off-shore wholesale repo-buyer, e.g. SWF, which has introduced fragility, pro-cyclicality and less Central Bank control. Hence, we argue the Fed's B/S is no longer the sole source of high-powered money, although they are fighting back. Looking ahead, the interesting question is China where our-take, using your terminology, is that monetary policy and monetary conditions remain closely (and rigidly) aligned.
Interesting piece. I would venture that policy changes since the GFC have likely tightened the link between policy and conditions. But this may unravel. Also if ‘Liquidity’ is in some sense a measure of the b/s capacity of financial intermediaries, it may be worth considering what drives each side of the financial sector b/s and whether assets or liabilities are exogenous or endogenous factors…. or both?
I can share with you some other research I've done, but basically I would argue that (at least in the US) the link between policy and conditions since the ~1970s or so was extremely fragile and dependent primarily on expectations management and for banks to behave in an appropriate manner to policy changes. Essentially, I believe that there was no "hard" mechanism of policy transmission, policy transmission relied on the assumption that the Fed could influence incentives to conduct balance sheet expanding interest rate arbitrage (maturity transformation, but also others) because reserves were supposed to be central.
Quantity/price of reserves may have been exogenous from the banks' perspectives, but after liability management was let out of the bag (and later market-based finance) the Fed totally lost any control over the ability to actually influence interest rate conditions and the system just worked like a bit of a magic trick (if you act in a manner that is consistent with "easing" then policy will have the effect of easing even if there is no "real" transmission mechanism aside from psychological influence). Moves by the Fed post-GFC imply that they understand this (somewhat) and attempting to rectify the decision (IOER, RRP, SRF, LIBOR --> SOFR, etc.).
I'd argue that money is far more endogenous (on both sides) than it is exogenous, and that the most important exogenous restraints today are regulatory in nature (LCR, SLR, etc.).
Thanks. I would agree with all these sentiments. The key change to the financing system has been the switch in sources of funding from the domestic retail depositor to the off-shore wholesale repo-buyer, e.g. SWF, which has introduced fragility, pro-cyclicality and less Central Bank control. Hence, we argue the Fed's B/S is no longer the sole source of high-powered money, although they are fighting back. Looking ahead, the interesting question is China where our-take, using your terminology, is that monetary policy and monetary conditions remain closely (and rigidly) aligned.