Fed Should Make Bond Buys a Regular Policy Tool, A Boston Fed Paper Finds

        By Pedro Nicolaci da Costa
        The Federal Reserve should consider keeping bond buys as a regular tool of monetary policy rather than return to a more conventional policy relying just on setting short-term rates, a newly-released paper from the Federal Reserve Bank of Boston says.
        In particular, the central bank's new de-facto third mandate, overseeing financial stability, might benefit from a broader array of available policy measures, argues Michelle Barnes, a senior economist adviser at the Boston Fed.
        "Largely missing from discussions about the Fed's 'exit strategy' is a consideration that perhaps it should retain, not discard, the balance sheet tools," Ms. Barnes writes.
        "Since the Dodd-Frank Act has added maintaining financial stability to the Fed's existing dual mandate to achieve maximum sustainable employment in the context of price stability, it might be beneficial to have several tools to achieve multiple policy objectives."
        In response to the financial crisis and its aftermath, the Fed has held short-term interest rates near zero since December 2008. It also has purchased trillions of dollars-worth of Treasury and mortgage-backed securities to hold down long-term rates in hopes of spurring stronger economic growth. It's portfolio of assets is now about $4.5 trillion, up from less than $1 trillion before the crisis.
        The Fed has stopped buying assets but is maintaining the size of its balance sheet by reinvesting the payments of principal on the bonds it holds. Fed Chairwoman Janet Yellen told the Senate Banking Committee in February the central bank had no plans to reduce the portfolio through asset sales.
        The Fed intends at some point to let the balance sheet shrink gradually by ceasing the reinvestment process, she said. The Fed's long-run intention is to hold "no more securities than necessary for the efficient and effective implementation of monetary policy," she added.
        But Ms. Barnes says the Fed should be open to buying more bonds in the future if necessary to influence interest rates and to maintaining a large balance sheet.
        "Having more than just one primary policy tool confers greater flexibility and may allow the Fed to better fulfill what are now its three policy goals," the author writes.
        "If the Fed were to keep its newer balance sheet tools, the future conduct of monetary policy may be more effective than in the recent past, and, ultimately, this better success would help the Fed burnish its reputation for true credibility in fulfilling the dual mandate and preserving financial stability," she adds.
        Related reading:
        Chatty Former Chairs Turn Up Fed Policy Noise
        Bernanke Suggests Fed Abandon Fed Funds Rates, Keep Balance Sheet Large
        (END) Dow Jones Newswires

        April 23, 2015 06:02 ET (10:02 GMT)

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