Must-know policy overview: The doves of the FOMC (Part 7 of 10)
Charles Evans
Dr. Charles Evans has been the president of the Federal Reserve Bank of Chicago since 2007. One of the most dovish Fed officials, he has supported the Fed’s monthly asset purchase program, which started in September 2012.
Limitations of the Fed funds rate as a policy tool
Dr. Evans believes that the Fed’s monetary policy is constrained by the zero lower bound Fed funds rate. The Fed’s main policy tool, the funds rate, has been near zero since December 2008. This factor has limited the Fed’s options for providing monetary stimulus because the rate can’t go down any farther. Also, three rounds of quantitative easing (or QE) have bloated the assets on the Fed’s balance sheet to ~$4.3 trillion from a pre-crisis level of less than $900 billion. As the need for monetary stimulus is reducing while the U.S. economy gains traction, the Fed is looking at normalization strategies to reduce the size of its balance sheet and increase the base rate.
An increase in the Fed funds rate has a ripple effect throughout the economy. This generally sends bond prices lower, since the fixed coupon rate they offer becomes less attractive relative to new issues at higher rates. ETFs like the ProShares Short 20+ Year Treasury (TBF), the HOLDRS Merrill Lynch Pharmaceutical (PPH), and the Vanguard Information Tech ETF (VGT), which has its major holdings in information technology companies like Apple Inc. (AAPL) and Google, Inc. (GOOG), could help investors, as they generally do well during the early part of a tightening cycle.
Evans is not in favor of tighter monetary policy
Evans views employment goals as a sustainable unemployment level between 5.2% and 5.6%. “Price stability” refers to the Fed’s long-term inflation target of 2%. A highly accommodative monetary policy was warranted to handle the financial instability risk. But such a policy can encourage additional risk-taking, according to Evans. However, he wasn’t in favor of a tighter monetary policy (the mechanics of raising the Fed funds rate) to reduce these risks in order to gain financial stability, as degrading monetary policy tools to mitigate financial instability risks would lead to inflation below target and additional resource slack.
Evans’ stance on monetary policy normalization
The Fed has already begun winding down its large-scale asset purchase program. The key issues are how to normalize the size of the Fed’s balance sheet and monetary tightening (the mechanics of raising the Fed funds rate). He suggests the use of tools such as interest on excess reserves, overnight reverse repo facilities, and term deposit facility, which may help raise short-term market interest rates in the presence of a large balance sheet.