PRAGUE, Czech Republic – On Tuesday, Federal Reserve Bank of St. Louis President James Bullard delivered remarks titled “U.S. Monetary Policy: Recent Developments” as part of a central bankers panel discussion at the 19th European Banking and Financial Forum in Prague.
During his discussion, Bullard explained how the Fed’s second round of quantitative easing was “a classic easing of monetary policy” and “an effective tool, even while the policy rate is near zero.” He also discussed the situation in early 2011, stating that “U.S. growth prospects remain reasonably good for 2011.” He added that recent global and domestic events “present considerable uncertainty, but can be resolved in benign ways.” Finally, Bullard talked about the path to normalization. “Discussion of the normalization of U.S. policy will likely return as the key issue in 2011,” he concluded.
Quantitative Easing as Classic Monetary Policy
Last November, the Federal Open Market Committee (FOMC) announced that the Fed would purchase Treasury securities at a pace of about $75 billion per month through the first half of 2011—the program commonly known as “QE2.” The Committee also stated that it would regularly review the program in light of incoming information and would adjust the program as needed.
Bullard said that even before the November decision, monetary policy was ultra-accommodative. He noted that the policy rate had been near zero for an “extended period” and that the Fed’s balance sheet was much larger than it had been before the crisis. Regarding the motivation for QE2, Bullard noted last summer’s “disinflation and declining inflation expectations,” adding that the “Japanese experience with mild deflation and a near-zero nominal interest rate has been poor.” Given the near-zero policy rate environment, Bullard said, “asset purchases can substitute for ordinary (interest-rate targeting) monetary policy.”
Bullard stated that the policy change had been largely priced into markets ahead of the November FOMC meeting, and the financial market effects were conventional. “In particular, real interest rates declined, inflation expectations rose, the dollar depreciated, and equity prices rose,” he said. “These are the ‘classic’ financial market effects one might observe when the Fed eases monetary policy in ordinary times.”
“This experience shows that monetary policy can be eased aggressively even when the policy rate is near zero,” Bullard said.
Bullard noted that the effects of monetary policy on the real economy lag from six to 12 months. “Real effects are difficult to disentangle because other shocks hit the economy in the meantime,” which, he added, is a standard problem in evaluating monetary policy.
The Situation in 2011
Bullard stated that, relative to last summer, U.S. growth prospects improved by early 2011. “Private sector forecasters and the FOMC all marked up their forecasts,” he said. “Anecdotal reports were more bullish,” showing “profitable businesses with considerable cash and an improving outlook.” He added, “An improving economy 18 months post-recession is generally a strong positive.”
Noting the improved economic outlook since QE2 was implemented, “the natural debate is how and when the exit should begin,” Bullard said. “However, additional uncertainty has clouded this picture.”
“In recent weeks, macroeconomic uncertainty has been on the rise from four key sources,” Bullard said. The four sources he discussed were:
- turmoil in the Middle East and North Africa and the associated uncertainty premium in oil prices;
- the natural disaster and the damaged nuclear reactors in Japan;
- the U.S. fiscal situation and the possibility of a government shutdown; and
- continued uncertainty regarding resolution of the European sovereign debt crisis.
Bullard pointed out that all four situations have the potential to escalate. If escalation occurs, he added, how and when to begin normalizing monetary policy would become less clear. “Still, the most likely prospect is that all four are resolved without becoming global macroeconomic shocks,” he said.
Normalization of U.S. Monetary Policy
Bullard said that U.S. monetary policy cannot remain ultra-accommodative indefinitely. “The process of normalizing policy, even once it begins, will still leave unprecedented policy accommodation on the table,” he stated. “The FOMC may not be willing or able to wait until all global uncertainties are resolved to begin normalizing policy.”
Bullard noted that normal monetary policy has two parts: “QE accommodation is removed by returning the balance sheet to an ordinary size over time,” and “the policy rate begins to approach levels associated with moderate expansion.” Bullard said that normalization will take time and added that it is the most difficult part of the business cycle for a central bank.
“Exit strategy was widely discussed in 2010, and that debate will likely revive during 2011,” Bullard said.