The Wilder View

Has the Fed changed its policy unannounced? PART 2

This post continues an article from last week titled Has the Fed changed its policy unannounced: Poole says yes. Further evidence – a huge shift in nonborrowed reserves since October – suggests that the Fed may have shifted its policy target away from the federal funds rate.

The Fed’s balance sheet is usually only followed by a few policy gurus, but with the Fed’s $1.3 billion in new liquidity measures, everybody is interested. Many questions have been raised regarding the Fed’s actual objectives, as the effective federal funds rate – which closed at 0.49% on November 20 – veers miles away from its target set by the Federal Open Market Committee (FOMC), currently 1%. Accordingly, William Poole suggests that the Fed has changed it policy target without announcement. If you need a refresher, see Poole’s interview on Bloomberg here.

A closer look at the construction of banking reserves (the H.3 tables) gives further evidence that Poole may be right.

` reserves_chart.png

The chart illustrates the level total reserves, excess reserves and nonborrowed reserves on a weekly basis since the beginning of 2008. Nonborrowed reserves (reserves acquired through methods other than borrowing from the Fed’s discount window, like interbank lending or deposits) have surged $290 billion since the two-week reserve period ending on October 22, 2008. An upward swing in nonborrowed reserve positions indicates that interbank lending activity has picked up substantially, which could signal that credit conditions are improving with the Fed’s aggressive liquidity actions.

I don’t buy it. Excess reserves are rising precipitously alongside the surge in nonborrowed reserves, as banks continue to hoard the Fed’s $1.3 trillion in new liquidity over the year. Credit conditions remain tight with new consumer and firm lending coming to a grinding halt (Calculated Risk gives a market-based argument that there has been little progress in credit improvement over the last few days).

A closer look at the construction of aggregate reserves shows that since October 22, nonborrowed reserves are surging while the growth in borrowed reserves is generally slowing.


With such dynamic shifts in borrowed and nonborrowed reserve positions, and little or no progress in keeping the effective federal funds rate in line with its target, I have to wonder if the Fed is targeting reserves again.

Paul Volcker targeted nonborrowed reserves in the 1970’s and early 1980’s, and borrowed reserves until the late 1980’s when Greenspan phased into interest rate targeting in the 1990’s. Nonborrowed and borrowed reserves appear to have taken a discrete jump, giving credence to Poole’s accusation that the Fed has changed its policy without announcement.

But the Fed made no such explicit announcement in the 1990’s. When the Fed shifted its gears back in the late eighties from a borrowed reserve target to an interest rate target (targeting the effective funds rate), it did so gradually. From Meulendyke (1998):

”The return to effectively targeting the funds rate occurred gradually because other alternatives ceased to work as expected, rather than as a result of specific decision by the FOMC.”

RW: The minutes in the 1990’s do not show any indication that there was an explicit announcement by the Fed until 1997 when the minute reporting changed. The first sentence of the FOMC minutes from the late 1908’s through July 1-2, 1997 always started with the following sentence (or some variant of it):

“In the implementation of policy for the immediate future, the Committee seeks to maintain the existing degree of pressure on reserve positions.”
RW: But at the next chronological FOMC meeting on August 19, 1997, the first sentence of the FOMC minutes switched to:
“In the implementation of policy for the immediate future, the Committee seeks conditions in reserve markets consistent with maintaining the federal funds rate at an average of around 5-1/2 percent.”
RW: The only announcement made, indicating that the Fed had indeed changed its policy target, occurred in the minutes of that particular FOMC meeting on August 19, 1997.
“In particular, the directive would in the future include specific reference to the federal funds rate that the Committee judged to be consistent with the stance of monetary policy. The Committee also modified the present sentence relating to the intermeeting bias in the directive to recognize that changes in the stance of policy are now expressed in terms of the federal funds rate. These changes were not intended to alter the substance of the directive or the Committee’s operating procedures.”
As far as my research goes, the Fed never made an official announcement regarding Greenspan’s move to target an interest rate before 1997. But Meulendyke (1998) suggests that the FOMC had been targeting – at least partially – the federal funds rate for some time.
The trend in nonborrowed reserves has changed markedly, and as Poole suggests, may be the result of new and unannounced Fed policy.Furthermore, I am not sure if we will ever get an official announcement of such a policy shift until well after the FOMC has phased out the old policy. At least for now, transparency (or lack there of) is not one of the Fed’s primary policy concerns.

Just a little food for thought.

Originally published at the News N Economics blog and reproduced here with the author’s permission.

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