- Purchases gave ‘bigger bang for the buck’ than Treasuries
- Low ‘natural rate’ could limit ammunition to fight crises
When the next crisis comes, don’t expect Federal Reserve Bank of San Francisco chief John Williams to try persuading his colleagues to pull a Mario Draghi.
The European Central Bank president has gotten creative with monetary policy as euro-area growth and inflation have remained sluggish despite rock-bottom interest rates. He’s tried charging banks for overnight deposits to encourage them to lend the cash instead, doling out long-term loans at ultra-low costs to credit institutions, and adding corporate bonds to his quantitative-easing program. He’s also employed measures that the Fed has also used, like signaling policy stance through forward guidance.
Draghi’s innovations would either come in second to tried-and-proven quantitative easing in the U.S. or would be purely off the table, in Williams’ view. While he didn’t directly address negative rates, he’s previously referred to them as an option but a remote one, and told MarketWatch on Friday that they’d come after more tested policies.
Here’s what Williams, who next votes on policy in 2018, said about other globally tested central-bank tools in an interview on Tuesday:
MBS Still Best
|“What we learned from the research from quantitative easing one, two and three is that the mortgage-backed securities purchases ended up having kind of the bigger bang for the buck than the Treasury purchases, or when we originally bought the agency debt, which was in QE1. So I think there are options in there, of what we could be buying for SOMA [System Open Market Account] -- for the Federal Reserve’s account -- but it seems like the one that was the most effective was buying the mortgage-backed securities and mortgage-related products.”|
Other countries have used different tools, Williams said, but housing market-tied asset purchases proved to be a particularly effective unconventional policy in the U.S. Williams says that mortgage-backed securities both transmitted policy through mortgage financing and had bigger spillovers on financial conditions, whereas Treasury purchases had a less significant spillover.
|“Basically doing longer-term discount window lending or longer-term lending to banks at very low interest rates -- I think that those kind of policies are possibilities, but I think the reason the ECB has tended to use them more aggressively is I think in European countries, banking finance plays a much bigger role in the financial system then it does in the U.S. So if you want to get money out there into the economy, it goes through banks, while in the U.S. it’s much more capital markets.”|
The ECB’s policy of giving credit institutions four-year loans with zero or potentially negative rates hasn’t struck a chord with Williams, who sees it as an inferior option for the structure of the U.S. economy.
|“The Federal Reserve Act basically allows us, for the SOMA account, the open-market account, to hold very limited types of securities. So there’s Treasury securities, the agency debt, and agency-related securities, so I think buying corporate bonds on the Open Market Account or other securities like that is just not allowed, we couldn’t do that.”|
Williams doesn’t see corporate bond purchases as an option for the Fed. There might be a possibility of buying other mortgage-related securities, he said, but “the beauty of the MBS program is you can buy them in large scale.”
While Williams currently views the U.S. economy as strong, having policy options matters because when the next crisis comes, interest rates could be far lower than they’ve been historically.
Williams and Fed monetary-affairs chief Thomas Laubach are often cited by Fed Chair Janet Yellen for their co-authored research on the so-called “natural” rate of interest -- the one that neither stokes nor slows growth. The economists have found that it fell sharply during the global financial crisis. Fed officials expect the natural rate to move from its current level toward 1 percent in the longer run. Adding in 2 percent inflation, that would mean an ending point of 3 percent for the federal funds rate.
“My own view is that a 3 percent nominal funds rate seems a reasonable estimate, but I could imagine lowering that over the next year or so if the data continue to show that we’re only growing a little above trend with very, very low interest rates,” Williams said. “The big worry about this is that -- even with a 3 percent normal fed funds rate, that is a very low starting point to have.”