HFSC TASK FORCE ON MONETARY POLICY HEARING
Overview
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On March 4, the House Financial Services Committee Task Force on Monetary Policy, Treasury Market Resilience, and Economic Prosperity held a hearing entitled “Examining Monetary Policy and Economic Opportunity.” Witnesses in the hearing were:
- Dr. Donald Kohn, Senior Fellow, Brookings Institution
- Joseph Wang, Principal, Monetary Macro LLC
- Norbert Michel, Vice President and Director, Center for Monetary and Financial Alternatives, Cato Institute
- Michael Konczal, Senior Director of Policy and Research, Economic Security Project
Below is a summary of the hearing prepared by Delta Strategy GroupDelta Strategy Group. It includes several high-level takeaways, followed by summaries of opening statements.
Key Takeaways
The following is a summary of the main topics explored in the hearing, with further details in the Discussion section below.
- Committee Chairman Hill (R-AR) questioned Kohn on whether the Fed would be more effective if its sole mandate was to achieve stable prices. Representative Huizenga raised the Fed Oversight Reform and Modernization (FORM) Act, emphasizing the need for a rules-based framework to enhance Fed transparency and accountability.
- Task Force Chairman Lucas (R-OK) emphasized the need to assess the effectiveness of the flexible average inflation targeting strategy (FAIT), noting that the ample reserves regime forced it to use administered rates rather than the supply of bank reserves to steer policy. He questioned the impact of quantitative tightening and whether the Fed should continue reducing its balance sheet. He also raised the need to reevaluate the Supplementary Leverage Ratio (SLR).
- Representative Barr (R-KY) questioned whether an increase in market liquidity and stability would help bring the long end of the yield curve down and provide the Fed with greater flexibility to lower the Fed funds rate and ease monetary policy, with agreement that it would.
- Democrats emphasized that recent policy uncertainty, tariffs, and fiscal decisions could undermine economic stability and increase costs. Representative Casten (D-IL) discussed how U.S. fiscal policy is at odds with the Fed’s monetary policy.
Opening Statements & Testimony
Task Force Chairman Frank Lucas (R-OK)
Our Task Force will focus on the fundamental role that U.S. Treasury debt plays in our economy and the resilience of the Treasury market, with attention to the recent stresses the market has faced and how to increase liquidity and stability for the market and its participants. The Fed’s move to the ample reserves regime forced it to use administered rates rather than the supply of bank reserves to steer policy. Dodd-Frank’s considerable expansion of the Fed’s regulatory and supervisory authority has exposed the Fed to more political pressures, threatening its monetary policy independence. The Fed is not unaccountable to Congress for its actions, particularly with remarkable changes described.
Task Force Ranking Member Juan Vargas (D-CA)
Some have argued that the Fed’s dual mandate has been a distraction from solely focusing on price stability, but maximum employment should not be on the chopping block. Chairman Powell said that the dual mandate has “served us well,” and that he “does not see the case to move forward with a single mandate of price stability.” I agree and intend to continue to advocate for the importance of preserving the Fed’s dual mandate. Central banks around the world function at their best when they are allowed to operate independently. The Fed must make decisions considering a much longer time horizon and why it is critical that monetary policy be insulated from external political pressure. The new Administration has brought in a wave of uncertainty, whether it is tariffs or the future independence of the Fed.
Committee Chairman French Hill (R-AR)
With rising debt levels, interest costs pose a growing risk to our fiscal health.
Committee Ranking Member Maxine Waters (D-CA)
Yesterday, Trump announced massive new import taxes on Americans and American businesses buying things from Canada and Mexico. Last week, Republicans voted to advance Trump’s budget and cut up billions in Medicaid funding, which could eliminate coverage for nearly 16 million people. We should reject these misguided policies that are raising the cost of living for most families while Elon Musk and the billionaire class push for their taxes to be cut.
Dr. Donald Kohn, Senior Fellow, Brookings Institution
In 2020, in response to a prolonged period of very low interest rates and persistent shortfalls of inflation, the Fed altered its strategy to ensure that inflation was high enough to average two percent over time, which in turn would keep interest rates high enough to give the Fed sufficient room to lower interest rates should an adverse shock hit the economy. The post-COVID recovery presented the Fed with a very different environment, and it is now reviewing its stance.
Adjusting an overnight interest rate is the main instrument the Fed uses to make progress toward these goals, and does not directly affect prices or employment, but influences prices in financial markets with changes in spending and the balance of aggregate demand and aggregate supply. With an indirect process, the effects of a policy on objectives will depend on how financial markets react to actual and expected policy, and then how households and businesses respond to changes in financial markets. The Fed needs to differentiate between shocks to financial conditions that happen on the demand side of the economy and those that happen on the supply side. Monetary policy is well suited to offset demand-side shocks, but it cannot offset an adverse supply shock, such as a rise in the price of a good due to a reduction in supply.
Joseph Wang, Principal, Monetary Macro LLC
The reliance on interest rate policy means that the economic impacts of monetary policy are primarily felt through interest rate-sensitive sectors. The Fed’s secondary tool is its balance sheet, which can influence interest rates and allocate credit, creating money out of thin air and lending directly to borrowers or indirectly through purchases of debt, and is essential to performing its lender-of-last-resort function. Regulatory policy places constraints and costs on the actions of banks, with more stringent regulation reducing the willingness of banks to take risks and impacting efforts around stronger banking system. A more constrained banking system also limits the supply of credit to the public, as small and medium-sized businesses are more heavily reliant upon banks for financing, while larger businesses tend to borrow directly from the capital markets. More stringent regulation also impacts the function of Treasury markets and the level of interest rates, with regulations like the SLR contributing to the strength of the banking sector but also to the malfunctioning of the Treasury market during the pandemic.
Norbert Michel, Vice President and Director, Center for Monetary and Financial Alternatives, Cato Institute
The Fed should ensure that it does not become the source of monetary-induced slowdowns or inflation, and it should remain transparent and directly accountable through elected officials. The optimal rate of inflation should vary with productivity, sometimes gently rising or falling. If the Fed mishandles monetary policy, it can also lead to an economic slowdown where output, employment, and income fall as the economy shrinks. The potential for monetary-induced slowdowns is there and must be considered during any efforts to reform the Fed and improve monetary policy. Slowdowns and inflation are why Congressional oversight of the Fed is so important, and why it is critical that Americans are given the opportunity to hold both Congress and the unelected officials at the Fed accountable. Providing funds, whether through loans or grants, to specific groups or companies is not an appropriate role for a central bank in a representative democracy.
Michael Konczal, Senior Director of Policy and Research, Economic Security Project
The key macroeconomic decision this year will revolve around whether or not Congress worsens the debt and deficit, which will put pressure on the Fed, interest rates, and Americans. This economy faces three immediate macroeconomic risks from the frankly irresponsible policies of this current administration: unexpected tariffs, weakened state capacity, and pressures on Fed independence. Publicly announcing high tariffs outside formal processes in an inconsistent and confusing manner weakens investment and risks inflation expectations. Immediate determinant of macroeconomics will come from fiscal policy, particularly how Congress handles the expiration of the Tax Cuts and Jobs Act (TCJA). If a recession happens, the plan of tariffs and spending cuts creates a potentially cruel double blow, where the proposed tariff packages could skyrocket costs for everyday goods, coupled with cuts to critical services as corporations benefiting from these tax cuts pass their costs on to consumers.
Discussion
Representative Lucas (R-OK): Where should the Fed look to target its balance sheet size, and is there an ideal level of reserves they should aim for? Do you think the Fed should reevaluate the SLR? Kohn: The Fed is aiming to reduce its balance sheet until reserves are just large enough to stabilize market interest rates. It is looking carefully at those market interest rates to see whether they have gone down or not. It is fine that the Fed is continuing to reduce its balance sheet because I do not see it as a big deal whether reserves are $2 trillion or $1 trillion. The Fed holds government securities on one side of its balance sheet, and it issues reserves to banks on the other side of the balance sheet; Wang: The SLR is essentially a regulation that makes banks hold capital based on the size of the balance sheet without regard to the riskiness of their assets. When you are looking at assets like reserves that are very liquid and have zero credit risk or Treasury securities that have no credit risk and are very liquid, it does not make sense to have to hold capital against those. There are also other countries that have regulations that do not require reserves in the SLR. Some adjustment there would significantly increase the capacity of the banking system and improve the functioning of the Treasury market.
Representative Vargas (D-CA): How can we agree on the independence and dual mandate of the Fed, but always move to limit Fed discretion? Do the recent EO’s get close to executive and excessive control of the Fed? Konczal: Accountability is important, and Congress’ Finance Committee sets the Fed’s goals. Chair Powell and other Fed Chairs have talked to Congress twice a year, with transparency in the way they discuss their actions and how they are carrying them out. What I would worry about is Executive control of daily functions and excessive control of priorities driven by short-term political gain. The main limitation on the Fed is that Congress sets the goals, so they do not have independence with respect to their objectives. To the extent that the administration can politicize the Fed functions of financial regulatory policy, there is no way to have a strict wall and separation between monetary policy and regulatory policy. It does not work in practice.
Representative Hill (R-AR): Would the Fed be more effective if its sole mandate was to achieve stable prices? What is the most important element of the Fed’s framework assessment, especially in regard purchasing power? Kohn: Yes, economists would agree that, over time, inflation is “everywhere and anywhere” as a monetary phenomenon. That does not mean that the money supply directly feeds inflation, but the Fed, in principle, can control inflation over longer periods of time. The level of maximum employment, the lowest possible unemployment rate, based on the Phillip’s Curve is inferred from the behavior of other variables. 2021 was a bad forecast, and the Fed was not alone in projecting that inflation was going to come down over 2022 within supply constraints. There was also too much pressure in the labor markets, with demand constraints. The bad forecast and forward guidance on interest rates were major reasons why the Fed took so long. If the Fed had gone a few months earlier, it could have made a difference.
Representative Huizenga (R-MI): How could rules, like the Taylor Rule, have impacted the Fed’s decision during the most recent economic downturn? What something like the FORM Act been a good start? Michel: If they had followed a rule, we would at least know what they are doing and why. Without it, there is no way to judge their performance because their actions are unclear. The FORM Act would have been a great starting point because it provides a flexible rule. They put a base rule in place, pick the rule that they like, and stick to it until they do not as long as they explain to Congress what they are doing that is different and why.
Representative Huizenga (R-MI): Has the Fed incentivized financial institutions to hoard reserves instead of putting capital to work for the real economy? Kohn: The liquidity regulations put a premium on holding liquidity, and the Fed’s need to look carefully at that as to whether they are over-incentivizing holding liquidity.
Representative Waters (D-CA): Will tariffs increase the cost of living, especially with the potential for retaliatory tariffs? Konczal: Tariffs will raise prices and impose burden on supply chains and industries, even if there were clear communications and a better process for implementing them. There is a real supply issue, but more money in American pockets can help by providing economic security and strengthening the labor force.
Representative Barr (R-KY): Would an increase in market liquidity and stability help bring the long end of the yield curve down? Is shrinking the balance sheet inflationary or disinflationary? Wang: Yes, I believe it would; Kohn: It is disinflationary to a minor extent. I agree that pulling it back puts a little bit of upward pressure on that ten-year yield and decreases the demand for Treasuries.
Representative Barr (R-KY): Was it a mistake to make a fifty-basis point rate cut two months before a major election? Kohn: The increase in the ten-year yield did not reflect the cut in the federal funds rate. There was very little increase in inflation expectations as measured in the market. It was mostly term premium over the next few months based on uncertainty created by the election, by financial and economic developments. It was not about the cut.
Representative Casten (D-IL): Are we seeing increased dollar deposits in non-U.S. Banks, with concerns about the strength of the dollar in lowering borrowing costs? What happens with a huge numbers of dollar deposits at the bank of China? Wang: If we have dollar distributors abroad, the Fed has FX sublines, where they will lend to foreign central banks, who in turn can support the dollar deposits in foreign jurisdictions. There is a possibility, depending on the jurisdiction, that this could create an issue where foreign adversaries could potentially create a that we would have backstop with taxpayer money; Kohn: It is important for the authorities in the US and globally to look for spots that might become unstable because of runs.
Representative Casten (D-IL): Are there any hidden risks sitting out there in the repo market, and should we be concerned about any broader contagion if there is a run on those dollars? Wang: Repo loans are secured by treasury collateral and are very safe. In the past, a lot were traded with a lot of risk and unsecure measures, but today’s is a more stable form of finance.
Representative Flood (R-NE): If we are unable to unwind quantitative easing measures (QE) in a timely manner due to concern with the treasury market, does that raise questions about how viable QE is as a long term sustainable monetary policy tool? Kohn: The Fed can still go out and buy more securities if they need to. Under the circumstances, there is really no relationship between the size of the balance sheet and inflation.
Representative Flood (R-NE): What lessons can we learn from the Fed’s use of Section 13(3) facilities in 2020, and how should Congress approach this authority in the future? Wang: The Section 13(3) facilities are growing, helping during the great financial crisis with money market problems and asset-backed commercial paper, and again in 2020 with corporate credits and mainstream lending facilities. They keep growing, and the Fed is, in effect, being the lender of last resort to everyone in the economy. It is worth thinking about whether that is the design of the Fed, and if it aligns with the wishes of Congress.
Representative Downing (R-MT): Does unprecedented spending make the Fed’s job of combating inflation more difficult? Kohn: The Fed still had the tools to combat inflation. The Fed could have fought the inflation, but there was difficulty analyzing it and difficulty figuring out when to move.