Compiled by Golden Finance, on Tuesday, US Federal Reserve Chairman Jerome Powell delivered a keynote address on the current economic situation and future policy expectations at the National Association for Business Economics (NABE) annual meeting in Philadelphia, Pennsylvania. Powell indicated that the Fed may conclude its balance sheet reduction in the coming months. The future direction of monetary policy will be driven by data and risk assessments. The balance sheet remains an important monetary policy tool, and an early halt to balance sheet expansion might have had a smaller impact. Rising labor market risks justify the September rate cut. Labor market expectations remain on a downward trend. Powell stated that everyone is watching the same unofficial employment data, with state-level unemployment claims being a good indicator. He believes that if the government shutdown continues and October data is delayed, the Fed will begin to miss data, complicating the situation. Powell added that even without new Bureau of Labor Statistics data (delayed by the government shutdown), privately produced labor market indicators and internal Fed research provide sufficient evidence to suggest a cooling labor market. "Available evidence" suggests that "layoffs and hiring remain low," while "households' perceptions of job opportunities and businesses' perceptions of hiring difficulties continue to trend downward."
Powell also said that the U.S. economy appears to be stable, despite the lack of recent data due to the ongoing government shutdown. On economic issues, Powell reiterated a theme from his recent remarks, stating that "no policy path is risk-free amidst the tension between employment and inflation targets." Nick Timiraos, a "Federal Reserve spokesperson," commented that Fed Chair Powell's speech on the balance sheet did several things: 1) It offered a mark-to-market assessment of the current outlook for quantitative tightening, given recent signs of strength in overnight lending rates; 2) It countered recent criticism (such as from U.S. Treasury Secretary Benson & Melson) that the pandemic support measures—implemented with broad support in Congress and the early days of the Trump administration—were absurd policy interventions. Powell acknowledged (as he has previously) that ending quantitative easing more quickly would have seemed wiser, but given the Fed's rapid and drastic change of course in 2022, such a move would have had no material impact on the macroeconomy. 3) It also defended efforts by bipartisan populist senators to strip the Fed of its ability to pay the interest on excess reserves (IOR), warning that removing this policy tool could cause even greater market damage. Peter, chief market economist at Spartan Capital Securities, Cardillo said he does not think Powell has changed his tune. On the one hand, he said that the economic foundation is solid, but at the same time he also pointed out that there is weakness. What he has done is to prepare the market for a series of rate cuts, but not necessarily in sequence. Peter Cardillo believes that Powell's words reveal that he will cut interest rates by 25 basis points at the end of this month, and then the Fed will assess the situation. If the labor market continues to be weak and leads to job losses, then he may prepare for a sharper rate cut of 50 basis points in December. Powell is preparing the market for a rate cut, but at the same time does not want the market to think that a rate cut is inevitable. He is using the weakness in the labor market as a hedge.
Here is the full text of Powell's speech:
Thank you, Emily. Thank you also to the National Association for Business Economics (NABE) for awarding me the Adam Smith Award. It is great to be able to work with my predecessors Janet Yellen and Ben Burke. I am deeply honored to be recognized with this award, along with Nanke and other past winners. Thank you for your recognition and for the opportunity to speak with you today.
Monetary policy can be more effective when the public understands the role of the Federal Reserve and why it operates. With this in mind, I hope to enhance your understanding of one of the more arcane and technical aspects of monetary policy—the Federal Reserve’s balance sheet. A colleague recently compared this topic to a visit to the dentist, but that comparison may be unfair to the dentist.
Today, I will discuss the important role our balance sheet played during the pandemic and some lessons learned. I will then review our ample reserve implementation framework and our implementation of Finally, I will briefly discuss the economic outlook.
Background on the Federal Reserve's Balance Sheet
One of the central bank's primary responsibilities is to provide the monetary base for the financial system and the broader economy. This base is made up of central bank liabilities. As of October 8, the liabilities on the Federal Reserve's balance sheet totaled $6.5 trillion, with three categories accounting for about 95% of the total. First, Federal Reserve Notes (that is, physical currency) totaled $2.4 trillion. Second, reserves (funds held by depository institutions at Federal Reserve banks) totaled $3 trillion. These deposits enable commercial banks to make and receive payments and meet regulatory requirements. Request. Reserves are the safest and most liquid assets in the financial system, and only the Federal Reserve can create them. An ample supply of reserves is essential to the safety and soundness of our banking system, the resilience and efficiency of our payment system, and ultimately, the stability of our economy.
Third is the Treasury General Account (TGA), currently approximately $800 billion, which is essentially the federal government's checking account. When the Treasury makes payments or receives payments, those flows of funds affect the supply of reserves or other liabilities in the system.
The assets on our balance sheet are composed almost entirely of securities, including $4.2 trillion in U.S. Treasury securities and $2.1 trillion in government-guaranteed agency mortgage-backed securities (MBS). When we add reserves to the system, we generally do so by purchasing Treasury securities in the open market and depositing them in the reserve accounts of the banks that trade with the sellers. This process, in effect, converts securities held by the public into reserves but does not change the total amount of government debt held by the public.
The Balance Sheet Is an Important Tool
The Federal Reserve's balance sheet is a key policy tool, particularly when the policy rate is constrained by the effective lower bound (ELB). When the COVID-19 pandemic struck in March 2020, the economy nearly ground to a halt, financial markets seized up, and a public health crisis threatened to turn into a severe and prolonged recession.
In response, we established a range of emergency liquidity facilities. These programs, backed by Congress and the Administration, have provided critical support to markets and have played a key role in restoring confidence and stability. At their peak in July 2020, these facilities had loans totaling just over $200 billion. As the situation stabilized, most of these loans were quickly withdrawn.
At the same time, the U.S. Treasury market—normally the deepest and most liquid market in the world and the cornerstone of the global financial system—was under tremendous stress and on the verge of collapse. We restored the normal functioning of the Treasury market by purchasing securities on a large scale. Faced with unprecedented market failures, the Federal Reserve purchased U.S. Treasury and agency bonds at an astonishing pace in March and April 2020. These purchases supported the flow of credit to households and businesses and fostered more accommodative financial conditions to support the economic recovery. This policy accommodative measure was important because we had already lowered the federal funds rate to near zero and expected it to remain at that level for some time.
By June 2020, we had slowed the pace of our bond purchases, but still maintained a monthly rate of 1,200... In December 2020, given that the economic outlook remains highly uncertain, the Federal Open Market Committee stated that it expected to maintain this pace of purchases "until the Committee has made further substantial progress toward its maximum employment and price stability goals." This guidance suggests that the Federal Reserve will not withdraw its support prematurely while the economic recovery remains fragile and faces unprecedented conditions.
We maintained the pace of asset purchases through October 2021. By then, it had become clear that high inflation was unlikely to subside without a strong monetary policy response. At our November 2021 meeting, we announced a gradual reduction in asset purchases. At our December meeting, we will reduce the pace of We doubled the pace of our asset purchases and indicated that asset purchases would end in mid-March 2022. Over the entire period, our securities holdings increased by $4.6 trillion. Some observers have raised legitimate questions about the size and composition of our asset purchases during the pandemic recovery. The economy continued to face significant challenges in 2020 and 2021 as successive COVID-19 outbreaks caused widespread disruption and loss. Throughout that turbulent period, we continued our asset purchases to avoid a sharp and unpleasant tightening of financial conditions while the economy remained highly vulnerable. Our thinking was influenced by recent events in which signals of balance sheet reduction triggered a significant tightening of financial conditions. We recalled the situation in December 2018 and the "taper tantrum" of 2013. Regarding the composition of our asset purchases, some have questioned the continued purchase of agency mortgage-backed securities (MBS) during the pandemic recovery, given the strength of the housing market. Beyond purchases specifically for market operations, the primary purpose of our MBS purchases, like our Treasury purchases, is to provide a buffer against the backdrop of a period when the policy rate was capped at the ELB. The extent to which these MBS purchases affected housing market conditions during this period is difficult to determine. Many factors influence the mortgage market, and many factors outside the mortgage market influence supply and demand in the broader housing market.
In hindsight, we could—and perhaps should—have stopped asset purchases sooner. Our real-time decision-making was designed to protect against downside risks. We knew we could reduce the balance sheet relatively quickly once we stopped, and we did. Research and experience show that asset purchases affect the economy through expectations about the future size and duration of the balance sheet. When we announced the tapering of quantitative easing, market participants began to price in its impact, leading to a premature tightening of financial conditions. An earlier stop could have made some difference, but it is unlikely to have fundamentally altered the economic trajectory. Nevertheless, our experience since 2020 does suggest that we can use our balance sheet with greater flexibility and confidence as market participants become more familiar with its use and our communications help them build reasonable expectations.
Some also argued that we could have been more explicit about the purpose of our asset purchases. There is always room for improvement in communication. But I think our statements spelled out quite clearly our objectives of supporting and sustaining smooth market functioning and helping to foster accommodative financial conditions. Over time, the relative importance of these objectives has evolved as economic conditions have changed. But they have never been in conflict, so it might not have seemed that this issue made much difference at the time. Of course, that wasn't always the case. For example, banking stress in March 2023 led to a significant increase in our balance sheet through our lending operations. We clearly distinguished these financial stability operations from our monetary policy stance. In fact, we were still raising our policy rate during that period.
Amplenty of Reserves Working Well
Moving to my second topic, our ample reserve system has proven to be very effective in controlling our policy rate well across a range of challenging economic conditions, while promoting financial stability and supporting a robust payments system.
Within this framework, ample reserve requirements have proven to be very effective in controlling our policy rate well across a range of challenging economic conditions, while promoting financial stability and supporting a sound payments system. The provision of reserves ensures ample liquidity in the banking system, while control of the policy rate is achieved through the setting of our regulated interest rates (the interest rate on reserve balances and the overnight reverse repo rate). This approach allows us to maintain interest rate control regardless of the size of our balance sheet. This is critical given the volatility and unpredictability of private sector liquidity demand and the significant fluctuations in autonomous factors that influence the supply of reserves, such as the Treasury's general account.
This framework has proven resilient regardless of whether the balance sheet is shrinking or expanding. Since June 2022, we have reduced the size of our balance sheet by $2.2 trillion, from 35% of GDP to just under 22%, while maintaining effective interest rate control.
Our long-standing plan is to cease balance sheet reduction when reserves rise slightly above a level we believe is consistent with ample reserve conditions. We may approach this point in the coming months, and we are closely monitoring various indicators to make this decision. Some signs of a gradual tightening of liquidity conditions have begun to emerge, including the general tightening of repo rates. The Committee's plans indicate that they will take prudent steps to avoid a recurrence of money market strains similar to those seen in September 2019. Furthermore, the implementation of the tools in our framework, including the standing repo facility and the discount window, will help contain funding pressures and maintain the federal funds rate within the target range during the transition to lower reserve levels. Normalizing the size of our balance sheet does not mean returning to pre-pandemic levels. Over the long term, the size of our balance sheet is determined by public demand for our liabilities, not by pandemic-related asset purchases. Non-reserve liabilities are currently approximately $1.1 trillion higher than before the pandemic, requiring a corresponding increase in our securities holdings. The demand for reserves has also increased, in part reflecting growth in the banking system and the broader economy. Regarding the composition of our securities portfolio, our current portfolio is overweight in long-term securities and underweight in short-term securities relative to outstanding Treasury securities. The allocation to long-term securities will be discussed by the Committee. We will gradually and predictably transition to our We aim to maintain our desired portfolio to allow market participants time to adjust and minimize the risk of market volatility. Consistent with our long-standing guidance, our goal is to maintain a portfolio composed primarily of Treasury securities over the long term.
Some have questioned whether the interest we pay on reserves imposes a heavy burden on taxpayers. This is not the case. The Federal Reserve earns interest income from the Treasury securities that back our reserves. Most of the time, the interest income we earn on our Treasury holdings is sufficient to cover the interest payments on reserves, resulting in significant remittances to the Treasury. By law, we remit all profits, after paying our expenses, to the Treasury. Since 2008, even including recent negative net income, we have remitted more than $900 billion to the Treasury. While our net interest income may be temporarily negative due to rapid increases in policy rates to control inflation, such events are extremely rare. Our net income will soon return to positive levels, as has typically been the case historically. Of course, negative net income does not affect our ability to conduct monetary policy or meet our financial obligations.
If we are unable to pay our reserve and If interest on other liabilities were to fall, the Federal Reserve would lose control of interest rates. The stance of monetary policy would no longer be appropriately adjusted to economic conditions, and the economy would drift away from our employment and price stability goals. Restoring interest rate control would require significant sales of securities in the near term to shrink our balance sheet and the amount of reserves in the system. The volume and pace of these sales could strain Treasury market functioning and jeopardize financial stability. Market participants would need to absorb the sales of Treasury and agency mortgage-backed securities, which would put upward pressure across the yield curve, raising borrowing costs for the Treasury and the private sector. Even after this turbulent and disruptive process, the banking system would remain less resilient and more vulnerable to liquidity shocks.
Most importantly, our ample reserve system has proven highly effective in implementing monetary policy and supporting economic and financial stability.
Current Economic Conditions and Monetary Policy Outlook
Finally, I will briefly discuss current economic conditions and the outlook for monetary policy. Although the release of some important government data has been delayed due to the government shutdown, we will regularly review various We also have a national network of contacts through the Reserve Banks who are providing valuable insights that will be summarized in tomorrow's Beige Book.
Based on the data currently available to us, it is fair to say that the outlook for employment and inflation does not appear to have changed much since the September meeting four weeks ago. However, data available before the shutdown suggested that the pace of growth in economic activity may have been more solid than expected.
While the unemployment rate remained low in August, job gains have slowed sharply, likely in part due to slower labor force growth due to lower immigration and a decline in the labor force participation rate. Downside risks to employment appear to have increased in this less dynamic and somewhat slack labor market. While official employment data for September are delayed, available evidence suggests that both layoffs and hiring remain low, and that both households' perceptions of job opportunities and businesses' perceptions of hiring difficulties continue to trend downward.
Meanwhile, the 12-month core personal consumption expenditures (PCE) inflation rate was 2.9% in August, slightly higher than earlier this year, as the core The rise in commodity inflation has outpaced the persistent deceleration in housing and services prices. Available data and surveys continue to suggest that the rise in commodity prices primarily reflects the effects of tariffs rather than broader inflationary pressures. Consistent with these effects, near-term inflation expectations have broadly risen this year, while most indicators of longer-term inflation expectations remain consistent with our 2% objective. The rise in downside risks to employment has altered our assessment of the balance of risks. Therefore, we believe it is appropriate to adopt a more neutral policy stance at the September meeting. As we strive to balance the tension between our employment and inflation objectives, there is no risk-free policy path. This challenge was evident in the divergence in Committee members' projections at the September meeting. I should reiterate that these projections should be understood as a range of potential outcomes, the probabilities of which will change as new information becomes available, thus influencing our decision-making at each meeting. We will inform policy based on the evolving economic outlook and the balance of risks, rather than on a predetermined path. Thank you again for this award and for inviting me to share with you today. I look forward to speaking with you.
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