Understanding the Fed’s Implementation Framework Debate

Understanding the Fed’s Implementation Framework Debate

While financial markets and the financial press focus closely on where the Fed sets interest rates, there is also a consequential debate occurring within the Fed about how it goes about setting and maintaining its chosen rate. In particular, after it shrinks its securities holdings swollen by successive rounds of quantitative easing, will the Fed return to conducting monetary policy roughly in the manner that it did before the crisis, or will it stick to the implementation framework it has essentially followed for the past decade? The outcome of that debate will have important consequences for the Fed’s future footprint within the financial system.

To better understand the debate, this note provides background on the mechanics of monetary policy; how Fed policy implementation evolved over the past decade, as it fought the financial crisis and the sharp contraction and extended period of weakness that followed; important ways that the Fed’s own post-crisis bank liquidity regulations have constrained its monetary policy choices; and the pros and cons of two different implementation frameworks. It concludes with a discussion of how current market conditions suggest that the Fed may be forced to decide on a framework much earlier than it had expected.

Next Post: About that Deregulatory Wave… View Next Post


Disclaimer:

The views expressed do not necessarily reflect those of the Bank Policy Institute’s member banks, and are not intended to be, and should not be construed as, legal advice of any kind.