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Tuesday, February 11, 2020 (10:00 AM) -- Monetary Policy and the State of the Economy
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Chairman of the Board of Governors of the Federal Reserve System, Jerome Powell, will testify on the conduct of monetary policy and the state of the economy. He will be the only witness.
Purpose
The Federal Reserve Act (FRA) directs the Chairman of the Board of Governors of the Federal
Reserve System (Board) to testify before the House Committee on Financial Services and the Senate Committee on Banking twice a year, in February and July, on how the Board handles monetary policy and its observations on economic developments. Each appearance requires the Board to supply the Committees with a written report known as the Monetary Policy Report.
In the 1970s, the United States experienced an unusual combination of high inflation and
unemployment referred to as “stagflation.” The Federal Reserve Reform Act of 1977 amended the Federal Reserve Act to pursue “…the goals of maximum employment, stable prices, and moderate long-term interest rates.” Since moderate, long-term interest rates remain low only in a stable price environment, these goals are generally thought of as a dual monetary policy mandate of maximum employment and price stability. The Federal Open Market Committee (FOMC) currently defines the inflation target as 2.0 percent but has not set a numerical target for maximum employment.
In order to provide the Federal Reserve with explicit policy instructions on how to achieve its dual
mandate, Congress passed the Full Employment and Balanced Growth Act of 1978, referred to as the “Humphrey-Hawkins Act.” The Act aimed to achieve balanced growth through control of production, maximum employment, price stability, balanced budget and balanced trade. It further stated explicit numeric unemployment and inflation goals and increased congressional oversight through the monetary policy reporting system.
Monetary Policy
The Federal Reserve traditionally managed monetary policy through open market operations
(OMO), the primary credit rate often referred to as the “discount rate,” and reserve requirements. The
FOMC decides OMO while the Board decides the discount rate and reserve requirements. OMO is how the Federal Reserve targets the fed funds rate through the buying and selling of Treasury securities from primary dealers. The discount rate is the rate that Reserve Banks charge member banks for short-term, collateralized loans. Reserve requirements are the shares of deposits that a member bank must maintain in cash against its liabilities. Reserve Banks offer interest on required and excess reserves. Recently, interest on reserves (IOR) has become a primary monetary policy tool. The Financial Services Regulatory Relief Act of 2006 allowed Reserve Banks to pay IOR.
Generally, adjusting these short-term rates dictates the availability of funds to be lent or borrowed in the economy, with increases causing borrowing to become more expensive leading to “tighter” financial conditions and slower economic activity while decreases causing borrowing to become less expensive leading to “looser” financial conditions and accelerated economic activity. When these rates change, other interest rates in the economy tend to adjust
accordingly.
Financial Crisis. The 2008 financial crisis led the Federal Reserve to take a novel approach to
monetary policy. To improve the overall financial conditions, the Federal Reserve reduced the fed funds rate to nearly zero and provided additional forward guidance to the markets that the Federal Reserve intended to keep interest-rates at this level for an extended period. However, this strategy proved insufficient as economic conditions worsened. As a result, the Federal Reserve engaged in large-scale asset purchases of Treasuries and agency mortgage-backed securities (MBS), referred to as quantitative easing (QE). The QE program, which lasted from November 2008 to October 2014,
significantly increased the size of the Federal Reserve’s balance sheet from $870 billion in August 2007 to $4.5 trillion in early 2015. The large balance sheet has resulted in the Federal Reserve remitting significantly more in net income to the Treasury.
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