Federal Reserve Unconventional Monetary Policy Options

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CRS Report for Congress Prepared for Members and Committees of Congress Federal Reserve: Unconventional Monetary Policy Options Marc Labonte Specialist in Macroeconomic Policy February 6, 2014 Congressional Research Service 7-5700 R42962
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Federal Reserve: Unconventional Monetary Policy Options Congressional Research Service Summary The “Great Recession” and the ensuing weak recovery have led the Federal Reserve (Fed) to expand its monetary policy tools. Since December 2008, overnight interest rates have been near zero; at this “zero bound,” they cannot be lowered further to stimulate the economy. As a result, the Fed has taken unprecedented policy steps to try to fulfill its statutory mandate of maximum employment and price stability. Congress has oversight responsibilities for ensuring that the Fed’s actions are consistent with its mandate. The Fed has made large-scale asset purchases, popularly referred to as “quantitative easing” (QE), that have increased the size of its balance sheet from $0.9 trillion in 2007 to about $4 trillion at the end of 2013. In September 2012, the Fed began a third round of monthly purchases of Treasury securities and mortgage-backed securities (MBS), referred to as “quantitative easing three” or QEIII. Unlike the previous rounds, the Fed has not announced when QEIII will end or its ultimate size. In December 2013, the Fed began “tapering off” its asset purchases, and announced in January 2014 that it would purchase $30 billion of MBS and $35 billion of Treasury securities per month. The Fed views QE as stimulating the economy primarily through lower long-term interest rates, which stimulate spending on business investment, residential investment, and consumer durables. Since QE began, Treasury yields and mortgage rates have reached their lowest levels in decades; it is less clear how much QE has affected private- borrowing rates and interest-sensitive spending. Critics fear QE’s potentially inflationary effects, via growth in the monetary base. Inflation has remained low to date, but QE is unprecedented in the United States and the Fed’s mooted “exit strategy” for unwinding QE is untested, so the Fed’s ability to successfully maintain stable prices while unwinding QE is uncertain, as are potential unintended consequences. The Fed has also changed its communication policies since rates reached the zero bound. From 2011 to 2012, it announced a specific date for how long it anticipated that the federal funds rate would be at “exceptionally low levels,” and over time incrementally extended that horizon by two years. In December 2012, it replaced the time horizon with an unemployment threshold. It now anticipates that the federal funds rate would be exceptionally low “well past the time that the unemployment rate declines below 6.5%,” provided inflation remains low. The Fed argues that its new communication policies make its federal funds target more stimulative today. In this view, if
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