Fed Thoughts: Known Unknowns

No drama attends the policy action announced at the conclusion of the meeting of the Federal Open Market Committee (FOMC) to be held on September 19th to 20th. Fed officials laid down a long set of rails to the terminus—the announcement of the start of the slowing of their reinvestments of maturing and prepaying securities. A gradual journey thereafter will trim their $4-1/2 trillion balance sheet. Where it ends—both as to the date and the ultimate portfolio adjustment—is unknown now because it depends on the evolution of the economy and financial markets in between.

Fed staff released studies, FOMC participants put markers down in the statement and minutes about acting "relatively soon," and virtually every official near a microphone assured of the appropriateness of the plan. When those agreeing span the range of Governor Brainard and Bank President Mester, with Chair Yellen and President Dudley in the middle, be confident that the congregation clusters in the same pew of the chapel. President Dudley of the New York Fed probably said this the most clearly, holding that "Not only is this shift in policy now widely anticipated, but we have also seen that the impact on the level of the long-term interest rate has been small as expectations have adjusted." Of course, the effect of quantitative easing is hard to quantify both coming and going but we think that the Bank president is right. Markets have healed since the crisis, investors are much less averse to risk, and the size of the Fed’s portfolio has shrunk relative to nominal GDP and total debt outstanding.

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