Grand Central: A War-Weary Fed’s Reluctant Embrace of New Weapon – Real Time Economics

The Wall Street Journal’s Daily Report on Global Central Banks for Thursday, July 10, 2014:

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Minutes of the Federal Reserve’s June policy meeting suggested central bank officials are not at all comfortable with a new tool being designed by the New York Fed to help them raise interest rates in the future.

The tool, called overnight reverse repos, involves trades the Fed conducts with money market funds and other non-banks. The money funds lend the Fed cash and it pledges its securities to them as collateral in return. The interest the Fed pays on these overnight reverse repo loans in theory should help set a floor on interest rates.

When the time comes to raise rates, in theory it should be able to raise the interest it pays on overnight reverse repos. Conversely if it wants to lower them, it can reduce this rate. Officials see it as a way to extend the Fed’s command of short-term rates beyond the banking sector with which it traditionally interacts, something necessary because the Fed has flooded the broad financial system with so much money since the financial crisis.

Minutes of the June meeting showed Fed officials discussed in great detail how extensively to use overnight reverse repos and were quite wary about proceeding very aggressively.

“While generally agreeing that an (overnight reverse repo) facility could play an important role in the policy normalization process, participants discussed several potential unintended consequences of using such a facility and design features that could help to mitigate these consequences,” the minutes said. Among the worries: investors might flock to these instruments and away from banks in a crisis; nonbanks were unknown and potentially risky counterparties for important monetary policy activity; the instruments could reshape the Fed’s involvement in financial activity in unknown or dangerous ways.

“Several participants emphasized that, although the ON RRP rate would be useful in controlling short-term interest rates during normalization, they did not anticipate that such a facility would be a permanent part of the Committee’s longer-run operating framework,” the minutes said.

A few months ago, many Wall Street analysts believed this program would become a bedrock of monetary policy in the future. The New York Fed’s former markets group chief – Brian Sack – heralded it as a key tool for monetary policy.

The Fed’s reluctance to embrace the tool shows how conservative officials tend to be about change, a contradiction given the radical measures the central bank has taken to battle financial crisis and slow recovery. It also shows that the process of moving away from easy money policies could be much more complex and unpredictable than officials expected when they launched the policies over the past five years.

Read Michael Derby’s story below for more detail on the program and the Fed’s evolving exit strategy.

-By Jon Hilsenrath


Fed Sets October End for Bond Buying. Federal Reserve officials agreed at their June policy meeting to end the central bank’s bond-buying program in October, closing a chapter on a controversial experiment in central-banking annals with results still the subject of immense debate.

More from the June Meeting Minutes:

Fed Officials Discussed Tools for Raising Interest Rates When the Time Comes.  They suggested a starring role for its tool that pays banks interest for parking reserves at the central bank and a secondary role for their benchmark federal funds rate and other new facilities they’re testing.

Divide on Inflation Views Growing. The minutes suggest there is a growing gap between officials who believe U.S. inflation could remain too low for comfort and those who believe a spike in consumer prices could be closer than forecasters think.

Fed Has Little Uncertainty, Despite Forecasting Misses. Fed policymakers have been consistently too optimistic about economic growth and too pessimistic about the falling unemployment rate. But ask them if they’re uncertain about their forecasts and this is their answer: no more than usual.

Fed May Have to Hike Sooner Than Market Expects, Says Former Obama Adviser. “I don’t think they are behind the curve, but they are getting closer,” Princeton University economics professor Alan Krueger said Wednesday during an appearance on CNBC. Mr. Krueger was head of Obama’s Council of Economic Advisers from November 2011 until August 2013.

China Central Bank Said Committed to Rate Reform. China’s central bank governor, Zhou Xiaochuan, on Thursday reiterated the intention to liberalize interest rates within two years but said the exact timing would depend on “good conditions” in the domestic and global economy.

China Exports Strengthen on U.S. Demand. Chinese exports grew in June on the back of strengthening U.S. consumer demand, in a positive sign for China’s factory sector and for the global economic outlook. The pace of export growth disappointed some economists, though others blamed the lingering impact of distortions in last year’s Chinese trade numbers used to make the comparison.  Economists React.

U.S. Companies Step Up Business Conducted in Yuan. American companies are conducting a record amount of business in Chinese yuan, looking to benefit from cost advantages over dollar transactions.

Draghi Calls for Euro-Zone Rules for Economic Reforms. European Central Bank President Mario Draghi on Wednesday called for a new set of rules for euro-zone members that would apply to economic reforms and be analogous to the standards that govern borrowing by governments. Mr. Draghi said differences in the competitiveness of the euro zone’s 18 member economies are as much a threat to its survival as differences in their debt loads. Watch Mr. Draghi’s speech here.

New TLTROs Will Make EUR200B Available for Italian Banks -Visco The new targeted long-term refinancing operations planned by the European Central Bank will potentially make more than 200 billion euros ($272,34 billion) available for Italian banks, ECB governing council member Ignazio Visco said Wednesday- Dow Jones Newswires.

Bank of France Noyer Recommends Limited Cut on Savings Rates. Bank of France Governor Christian Noyer Thursday recommended not applying the formula for calculating the rate on France’s popular regulated savings account and limiting the rate cut to protect consumer spending power. – Dow Jones Newswires.

Euro-Zone House Prices Fell for Second Quarter. Euro-zone house prices fell for the second straight quarter in the three months to March, underlining the weak nature of the currency area’s economic recovery.

BOE On Hold Amid Criticism Of Rate Guidance. The Bank of England left the U.K.’s benchmark interest rate unchanged Thursday amid criticism that officials are sending confusing signals on when borrowing costs will eventually start to rise.

BOE Appointee Says Its Balance Sheet May Never Return to Pre-Crisis Size. The official who will be in charge of shrinking the Bank of England’s balance sheet said Wednesday it may never get back to the size it once was. Nemat Shafik, a former International Monetary Fund deputy managing director, joins the U.K. central bank on Aug. 1 as its first-ever deputy governor for markets and banking.

Mr. & Mrs. Watanabe Skeptical of Mr. Kuroda. The Bank of Japan’s strategy to end the country’s long slump rests as much on psychology as on economics. There’s actually no econometric model that directly connects the ongoing massive money-printing program to the central bank’s plan to generate 2% inflation by next year. BOJ officials openly admit the campaign will only work if enough people believe in it — if the Japanese public understands the central bank’s policies and expects them to transform the economy, then changes their behavior in ways that really do change the economy.

Sweden Mulls Encouraging Mortgage Repayment. Sweden is debating how to sway borrowers to repay at least part of their mortgages in a bid to reduce soaring household debt that is seen as a major threat to the domestic economy. The governor of Sweden’s central bank, Stefan Ingves, said last week that authorities need to act now to stop the debt buildup from reaching a point that would cause the economy to tumble.

Bank of Korea Board Member Breaks Ranks, Spurring Rate Cut Talk. All of sudden, economists are speculating about a Bank of Korea rate cut.The BOK kept its policy rate on hold for a 14th straight month on Thursday, but what set central bank watchers buzzing was news that it was the first non-unanimous vote on the policy board vote over that same period.

Hungary Close to Last Rate Cut, Central Bank Deputy Governor Says. Hungary is very close to the end of its rate cutting cycle, one of the deputy governors of the central bank’s rate setting council said in an interview published Thursday. The end of the cycle is very near, there’s a certain point that we mustn’t go beyond,” Ferenc Gerhardt told online business portal “This point is around 2%.” – Dow Jones Newswires.

Bank Indonesia Keeps Overnight Benchmark Rate Unchanged at 7.50%. Bank Indonesia Thursday left its overnight benchmark rate unchanged at 7.50%. The decision was expected by all 10 regional economists surveyed by The Wall Street Journal. – Dow Jones Newswires.


The American Dream has a big new buyer: the Chinese. Foreign purchases of U.S. residential real estate jumped 35% last year, with Chinese buyers leading the way, according to a survey published this week by the National Association of Realtors.


-House Financial Services Committee holds a hearing at 10 a.m. EDT on legislation to change the way the Fed operates

-Kansas City Fed’s George speaks on the U.S. economy and monetary policy at 1:15 p.m. EDT in Shawnee, Okla.

-Fed Vice Chairman Fischer speaks on financial-sector reform at 4:30 p.m. EDT in Cambridge, Mass.


The Long-Term Unemployed, U.K. Wages and Labor-Market Slack. There’s more slack in the U.K. labor market than Bank of England officials believe, write David N.F. Bell and David G. Blanchflower in a new working paper from the Peterson Institute for International Economics. “Our paper contests the view that the long-term unemployed, because of their supposed greater distance from work, should be treated as a different category when assessing the level of slack in the U.K. labor market. Microeconometric evidence from the United States and our evidence from the United Kingdom, cannot distinguish any statistically significant difference between long-term unemployment and overall unemployment in their effects on wages. There is zero empirical justification for focusing only on the short-term unemployed when calibrating slack in the U.K. labor market.”


The Fed often is called on to provide emergency lending during financial crises, but anticipation of such lending could make such crises more likely to occur in the first place, write Richmond Fed President Jeffrey Lacker and the regional reserve bank’s Renee Haltom in an essay. “Given the costs of emergency lending — in terms of increasingly prevalent moral hazard and risk-taking in the financial system and the likelihood of political entanglements that compromise the Fed’s monetary policy independence — there is a strong argument for scaling back the Fed’s authority to conduct emergency lending.”

The new House Republican bill to change the Fed’s operations is “audit the Fed on steroids,” Brookings Institution senior fellow Sarah Binder writes in the Washington Post’s Monkey Cage blog.  “The bill crosses the boundary between setting the Fed’s policy goals and determining its policy instruments. Most congressional efforts to influence monetary policy only do so indirectly — for instance setting the Fed’s mandate or altering its governance structure.  But the bill walks right up to the point of setting the Fed’s choice of policy instruments.”

Fed Chairwoman Janet Yellen, in her speech last week, “didn’t rule out the use of interest rate policy for the purpose of securing financial stability at some point in the future, but she set the bar very high,” write Stephen G. Cecchetti and Kermit L. Schoenholtz, on their web site Money, Banking and Financial Markets.  “The risk is that the message will be viewed as a policy commitment beyond that warranted by our limited knowledge.”

Who benefits from low inflation and higher interest rates? “Rich old men,” writes Paul Krugman on his New York Times blog. “Basically, inflation redistributes wealth down the scale of both wealth and age, while deflation does the reverse. And therein lies the deep explanation for inflation hysteria. The Fed’s efforts to boost the economy haven’t had the disastrous effects the usual suspects predicted, but it’s nonetheless true that this is no policy for rich old men (ROMs?).”


-Ghana’s central bank on Wednesday raised its policy interest rate to 19% from 18% “to contain inflation pressures and realign interest rates in favour of domestic assets.”

Russia saw $74.6 billion in net capital outflow in the first half of 2014, more than for the whole of 2013, the central bank’s data showed Wednesday.

-Australia’s unemployment rate rose to a higher-than-expected 6% in June from 5.9% in May as more people than anticipated began looking for work.

-An early U.S. experiment with central banking began to end 182 years ago today. On July 10, 1832, President Andrew Jackson vetoed legislation that would have extended the charter of the Second Bank of the United States. Mr. Jackson said he was “deeply impressed with the belief that some of the powers and privileges possessed by the existing bank are unauthorized by the Constitution, subversive of the rights of the States, and dangerous to the liberties of the people.”

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