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March 25, 2016 at 09:45 AM
Ben Bernanke never seems to be at a loss for ideas. The former Federal Reserve Board chairman who introduced a massive program of quantitative easing in the U.S. during the Great Recession has just written a new blog suggesting another potential, novel strategy the Fed could use to address the next slowdown – targeting longer term interest rates. (The latest blog is the second in a two-part series; the first installment focused on negative interest rates.)
At the outset, Bernanke admits that “it is unlikely that exotic policy tools like negative rates or targeting longer-term interest rates will be used in the U.S. in the foreseeable future” but notes that just talking about them can influence investors’ expectations. That, in turn, can alter markets, and paradoxically make it easier for the Fed to achieve policy goals or targets without ever taking the suggested action.
“Educating the public and market participants about more-radical monetary policy alternatives might help ensure that those alternatives are never needed,” writes Bernanke.
Some Perspective on the Fed’s Toolbox
Before recounting what Bernanke is suggesting in his latest blog, it’s important to remember what the Fed has done up until now to revive a faltering economy. Its most common tool is to lower short-term interest rates, specifically the federal funds rate, which is the rate banks charge each other for overnight loans. The current Fed Funds rate is 0.25% to 0.50%, up from a range of zero to 0.25%, which prevailed for seven years, until December.
But during the financial crisis, the Fed also initiated a policy of quantitative easing for the first time, buying huge quantities of long-term Treasury bonds and mortgage-backed securities in order to lower long-term rates and therefore boost borrowing on the part of consumers and businesses. The Fed ended those purchases in late 2014 but continues to roll over maturing debt so its balance sheet remains near $4.5 trillion.
Now former Bernanke is suggesting another strategy: targeting intermediate-term rates, specifically the rates on two-, three- and five-year Treasuries.
How Fed Rate Targeting Would Work
