Jul 8, 2019

Scott Sumner’s Questions for Fed Chairman Powell

Scott Sumner Ralph G. Hawtrey Chair of Monetary Policy

During the annual Humphrey-Hawkins testimony, members of the House and Senate often ask for explanations of previous Fed actions, or lack of action, in areas of interest to Congress. When discussing the details of monetary policy, however, Representatives are at a distinct disadvantage, as Fed officials often have much more expertise than people outside the world of central banking. In that environment, the most effective questions will be those that central bankers will welcome, rather than skillfully deflect.  

In the 21st century, one of the most important issues facing central banks is how to conduct monetary policy at near-zero interest rates. Central banks such as the Fed have traditionally provided monetary stimulus via interest rate cuts. Because Fed officials have indicated that negative interest rates are not being contemplated, it is not clear how to provide an adequate level of policy stimulus the next time that nominal interest rates fall to zero—the so-called “zero lower bound.” Thus Congress might want to ask the Fed these three questions:

1. Do Fed officials believe that the Federal Reserve currently has adequate tools to achieve their mandate at the zero lower bound, without assistance from fiscal policy?

2. Would the Fed be more confident in its ability to achieve the dual mandate of stable prices and high employment if it were authorized to buy a wider range of assets at the zero lower bound?

3. Suppose the Fed were allowed to boost its capital by retaining several years’ worth of profits. Would this make the Fed more willing to provide adequate liquidity at zero interest rates, knowing that it is less likely to become insolvent if the assets on its balance sheet declined in value?

Here’s how to think about these three questions:

1. Most economists believe that fiscal stimulus might be necessary during the next recession. I think that’s wrong, but what really matters is what the Fed believes.

2. The second question addresses the Fed’s ability to do enough “quantitative easing” (QE) to hit its Congressional mandate. If the Fed does not have that ability at the zero lower bound, it would be because Congress restricts the type of assets they can purchase. In that case, the Fed might not have enough “ammunition” to achieve their target for low inflation (two percent) and high employment. Allowing the Fed to buy a wider range of assets when interest rates fall to zero would give the Fed more ammunition. It would also make it less likely that they need to use that ammunition.

3. Even if the Fed has adequate legal authority to purchase assets, they might hold back from doing enough QE to hit their policy target out of fear that a future decline in the price of bonds in their portfolio could make the Fed insolvent. If the Fed were allowed to hold more capital, it would greatly reduce the (already low) risk of insolvency.

These three questions could generate a useful conversation. Congress is probably not well-suited to micromanaging the Fed’s day-to-day decisions. Rather, Congress needs to make sure that the Fed has the tools to fulfill the dual mandate. These questions would determine whether the Fed needs additional tools at the zero lower bound, and if so, which ones would be most useful.

Photo credit: Mark Wilson/Getty Images

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