Some Fed Bond Purchases Spurred Hiring, Central Bank Paper Says

WASHINGTON—At least some of the Federal Reserve’s bond buying in the wake of the 2008 financial crisis bolstered employment, according to a recent paper by staffers at the central bank’s board of governors.

The third round of such purchases, also known as quantitative easing, starting in late 2012, spurred banks with large holdings of mortgage-backed securities to lend more to companies, authors Stephan Luck and Tom Zimmermann found. Shortly thereafter, U.S. counties with such banks saw faster employment growth—up to 0.4 percentage point more per quarter—than counties where banks held fewer mortgage-backed securities.

Employment growth in the two sets of counties was similar for more than 18 quarters before the implementation of QE3, as the program was known.

The findings come as policy makers continue to debate the full impact of the unconventional stimulus measures taken by the Fed after interest rates, reduced to near zero by the end Continue reading "Some Fed Bond Purchases Spurred Hiring, Central Bank Paper Says"

Deflation Risks May Warrant Radical New Central-Bank Thinking, the IMF’s Chief Economist Says

IMF Economic Counselor Maurice Obstfeld at a press conference at the annual meetings in Lima, Peru, last month. “I worry about deflation globally,” he said in a recent interview. “It may be time to start thinking outside the box.”
STEPHEN JAFFE/IMF VIA GETTY IMAGES
The Bank of Japan and other central banks around the world may need to try radical new easy-money policies to stave off the rising specter of deflation and revive sickly economic prospects, the International Monetary Fund’s new chief economist warns. “I worry about deflation globally,” new IMF Economic Counselor Maurice Obstfeld said in an interview ahead of an annual IMF research conference that focuses this year on unconventional monetary policies and exchange rate regimes. “It may be time to start thinking outside the box.” Weak—and in some cases falling—price growth has plagued Japan, Europe, the U.S. and other major economies since the financial crisis. Continue reading "Deflation Risks May Warrant Radical New Central-Bank Thinking, the IMF’s Chief Economist Says"

Fed Policy May Have Widened America’s Wealth Inequality, Philadelphia Fed Paper Says

The Fed’s unconventional monetary policy does not strive at redistribution, but some is hard to avoid, says a new Philadelphia Fed paper.
Bloomberg
Federal Reserve policies launched in a historic economic slump may have exacerbated wealth disparities in the U.S., according to new research from the Philadelphia Fed. “Monetary policy currently implemented by the Federal Reserve and other major central banks is not intended to benefit one segment of the population at the expense of another by redistributing income and wealth,” writes economist Makoto Nakajima in the second quarter edition of the regional central bank’s Business Review. “However, it is probably impossible to avoid the redistributive consequences of monetary policy,” the paper says. Such effects are especially pronounced when the central bank undertakes a concerted monetary stimulus as it did during the financial crisis of 2008 and the weak economic recovery that followed, the report says. Official borrowing Continue reading "Fed Policy May Have Widened America’s Wealth Inequality, Philadelphia Fed Paper Says"

The Fed’s Zero-Rate Policy Boosts Inequality, Nobel Economist Joseph Stiglitz Says

Joseph Stiglitz, Nobel prize-winning economist and professor of economics at Columbia University, says the Fed’s aggressive monetary policies may have further boosted U.S. inequality.
SIMON DAWSON/BLOOMBERG NEWS
The Federal Reserve’s prolonged policies of near-zero interest rates and asset purchases have further widened the already large gap between the rich and poor in the United States, says Nobel prize-winning economist and Columbia University professor Joseph Stiglitz. “Contrary to the presumption in the nineteenth century, where lower interest rates favored debtors over creditors and thus increased equality, we show that…lower interest rates may actually increase inequality,” Mr. Stiglitz, a long-time inequality scholar, argues in the fourth of a four-part working paper series published by the National Bureau of Economic Research. That’s because rich individuals tend to hold much of their wealth in a stock market that benefits disproportionately from such policies, which included purchases of government and mortgage bonds, Continue reading "The Fed’s Zero-Rate Policy Boosts Inequality, Nobel Economist Joseph Stiglitz Says"

Fear Bond Buys Would Spark Inflation Misplaced, Cleveland Fed Says

A new Cleveland Fed paper finds no support for fears of hyperinflation due to bond buying.
BLOOMBERG
Worries that the Federal Reserve’s bond buys would lead to runaway inflation were misguided and have proven incorrect, according to new research from the Cleveland Fed. In response to the deep recession and financial crisis in 2007-09, the Fed cut short-term interest rates to near zero and undertook three programs of large-scale purchases of mortgage and Treasury bonds, known as quantitative easing. “Such measures caused an unprecedented increase in the Fed’s balance sheet and led some to fear that high inflation would soon follow,” writes economist Mehmet Pasaogullari in the regional central bank’s latest Economic Commentary. “Historical data for various measures of expected inflation did not provide any support for those fears. In addition, a look at the past six years shows that these fears have not materialized.” The central bank’s balance
Continue reading "Fear Bond Buys Would Spark Inflation Misplaced, Cleveland Fed Says"

A New, Lower Normal for Fed Rates? Fed Officials’ Lively Debate

Fed officials debated whether there is a lower, ‘new normal’ level of neutral interest rates at their April meeting, minutes showed. 
J. SCOTT APPLEWHITE/ASSOCIATED PRESS
Did the financial crisis and Great Recession permanently slow the U.S. economy’s growth potential, thereby lowering the point at which the Federal Reserve’s benchmark interest rate should be considered neutral? Fed officials waded into this debate at their April policy meeting, but there was little agreement, according to minutes of the discussions released Wednesday. The concept of the “equilibrium” rate of interest is esoteric but important for Fed officials as they consider how much to raise their benchmark rate, the federal funds rate, from near zero in coming years.
The minutes defined the equilibrium rate as the level of the fed funds rate, adjusted for inflation, “rate consistent with the economy achieving, over a specified time horizon, maximum employment and price stability.” Continue reading "A New, Lower Normal for Fed Rates? Fed Officials’ Lively Debate"

San Francisco Fed Sticks to Rosy Forecast Despite Recent Weakness

A wobbly start to the year is not deterring economists at the Federal Reserve Bank of San Francisco from a fairly upbeat growth outlook for 2015. “With winter behind us, we expect above-trend growth to resume in the second quarter and continue for the rest of 2015,” writes Mary Daly, senior vice president and associate director of research at the San Francisco Fed, in a recent research note. “Accommodative monetary policy along with ongoing improvements in credit market conditions, asset values, and household incomes related to the strong labor market all are expected to help sustain this solid growth.”

Many economists have cut back their first quarter growth forecasts to below 2%, with some attributing much of the unexpected weakness to another unusually harsh winter. Ms. Daly echoed that view. “Much of the weakness can be traced back to severe winter weather in the Midwest and East Coast
Continue reading "San Francisco Fed Sticks to Rosy Forecast Despite Recent Weakness"

Fed Should Make Bond Buys a Regular Policy Tool, A Boston Fed Paper Finds

The Federal Reserve Board’s building in Washington
Andrew Harrer/Bloomberg News
The Federal Reserve should consider keeping bond buys as a regular tool of monetary policy rather than return to a more conventional policy relying just on setting short-term rates, a newly-released paper from the Federal Reserve Bank of Boston says. In particular, the central bank’s new de-facto third mandate, overseeing financial stability, might benefit from a broader array of available policy measures, argues Michelle Barnes, a senior economist adviser at the Boston Fed. “Largely missing from discussions about the Fed’s ‘exit strategy’ is a consideration that perhaps it should retain, not discard, the balance sheet tools,” Ms. Barnes writes. “Since the Dodd-Frank Act has added maintaining financial stability to the Fed’s existing dual mandate to achieve maximum sustainable employment in the context of price stability, it might be beneficial to have several tools to achieve multiple policy objectives.”
Continue reading "Fed Should Make Bond Buys a Regular Policy Tool, A Boston Fed Paper Finds"

Chatty Former Chairs Turn Up Fed Policy Noise

Paul Volcker, former Federal Reserve chairman, told The Wall Street Journal Wednesday the Fed’s large balance sheet concerns him.
brendan smialowski/Agence France-Presse/Getty Images
Paul Volcker is the latest former Federal Reserve chairman to chime in on central bank policy. Mr. Volcker on Monday lamented the Fed’s large balance sheet, which grew rapidly after the 2008 financial crisis when Ben Bernanke was chairman and Janet Yellen was vice chairwoman. The Fed’s portfolio of assets grew to around $4.5 trillion from less than $1 trillion in recent years through three rounds of bond-buying aimed at spurring stronger economic growth. “The Federal Reserve should not be so dominant in the markets,” Mr. Volcker told The Wall Street Journal after a press conference detailing his recommendations for financial regulatory reform. His comments come less than a week after Mr. Bernanke suggested in his blog that the Fed should consider maintaining a large balance sheet. “I wonder if the case for keeping the balance sheet somewhat larger than before the crisis has been adequately explored,” he said. The Fed is maintaining the size of its balance sheet by reinvesting the payments of principal on the bonds. Ms. Yellen, now Fed chairwoman, told the Senate Banking Committee in February the central bank had no plans to reduce the portfolio through asset sales.

The Fed intends at some point to let the balance sheet shrink gradually by ceasing the reinvestment process, she said. The Fed’s long-run intention is to hold “no more securities than necessary for the efficient and effective implementation of monetary policy,” she added. “What they are doing now, I’m not commenting on,” Mr. Volcker said, but “I don’t want it as a permanent thing. If it’s necessary now, that’s their judgment and I’m not going to second guess them, but over time you don’t want” the Fed to play a dominate role in bond markets. Mr. Bernanke, in contrast, said in his blogpost there could be a number of advantages to keeping a big balance sheet. He noted, “Most other major central banks have permanently large balance sheets and are able to implement monetary policy without problems.” Mr. Volcker also repeated his view, which contrasts with current Fed policy, that low inflation should not be viewed as problematic. Inflation has been running below the Fed’s 2% target for nearly three years, and officials say they won’t start raising interest rates until they are reasonably confident inflation will move up toward that goal. “I think it’s fine. We haven’t got much inflation, and people don’t expect much inflation and that’s a good thing,” Mr. Volcker said. “I’m not somebody that worries about inflation being too low.”

Related reading:

5 Ways Paul Volcker Would Change Oversight of the Financial Sector

Yellen and Bernanke Go Separate Ways on Exit Strategy

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Cash Policies for Startups

I heard a rumor on a call the other day that some startup companies are starting to keep balance sheet cash in higher yield instruments such as corporate debt. This is apparently becoming trendy again as private companies do $25m+ rounds and end up with a bunch of cash on their balance sheets. This scares the shit out of me. As a high growth startup, I think you should be focusing on maximum protection for your cash, even if the yield is 0%. In 2001, we had several companies lose over $1m (including one that was public that lost $7.5m) in corporate bonds, which were being pushed on startups by the various banks as “safe.” We also had at least one case of a mess in the 2008-2009 time period with someone with one of those fancy action rate securities that froze cash for a while (they eventually got it.) And when I say “lose”, I mean the cash just vaporized. I remember seeing the email about the public company that has $7.5m disappear from their balance sheet. It was a powerful signal, at which point I actually spent time learning about the corporate debt market. It’s a good case of “it’s nice until it isn’t, and then it’s really not nice.” It’s probably even more severe today. Don’t fall into this trap. It’s worth double checking your cash / treasury policy at your next board meeting and making sure your board knows where your cash is. And, more importantly, if you are CEO, knowing where your cash is. Be careful out there. The scary monsters are starting to hang out at the bar again. They look really cute, cuddly, and intriguing, until they don’t and chomp down on a random body part. Hint: US Government Treasuries are good. The post Cash Policies for Startups appeared first on Feld Thoughts.

Fed Sent Nearly $97 Billion to the U.S. Treasury in 2014

The Federal Reserve had earlier estimated its 2014 remittances at $98.7 billion.
Reuters
The Federal Reserve handed a record $96.90 billion in profit over to the Treasury Department in 2014, the U.S. central bank said Friday. In January, the Fed had tentatively estimated its Treasury remittances last year at $98.7 billion. The slightly lower number was released as part of the Fed’s audited annual financial statements. The central bank’s revenue from various sources is used to cover its operating expenses, and much of the rest goes to the Treasury to help fund the federal government. In 2013, the Fed sent $79.63 billion to the Treasury, down from $88.42 billion in 2012. The Fed earns interest income on the huge portfolio of bonds that the central bank purchased in recent years to support the U.S. economy through a financial crisis, deep recession and painfully slow recovery. It concluded its latest round of bond-buying in October. The Fed’s remittances are expected to decline in coming years as it raises short-term interest rates and allows its bond portfolio to gradually shrink. The Fed’s assets totaled $4.498 trillion at the end of 2014, up from $4.024 trillion a year earlier, according to Friday’s report.

Fischer: Fed Closer to Rate Rises, But Exact Timing Remains Unclear

The Federal Reserve‘s second-in-command said Friday raising rates at some point over the middle of the year isn’t set in stone. Fed Vice Chairman Stanley Fischer acknowledged broad-based expectations that the Fed will raise rates at either its June or September policy meetings, but added they could easily be foiled. “We are getting closer” to rate rises, the official said. But he added “things could happen” that would change the calculus for rate rises. When it comes to acting at the meetings favored by market participants, Mr. Fischer said, “I don’t know whether we will or whether we won’t.” Mr. Fischer also said he doesn’t expect the U.S. central bank to follow any sort of predetermined path when the day arrives to begin raising short-term interest rates. He said there has been “excessive attention” paid to the issue of when rates will be lifted, and not enough to attention to what happens with short-term rates once they’ve been boosted off of their current near-zero levels. Mr. Fischer was speaking at a conference about monetary policy held by the University of Chicago’s Booth School of Business. While he didn’t offer any firm guidance about the timing of rate rises most see happening this year, he argued that central bank watchers and market participants need to start thinking more about rate rises will proceed over time. Other Fed officials have also decried the focus on the timing of the Fed’s first move, saying such an action might matter a lot to market, but not that much to the broader economy. Continue reading "Fischer: Fed Closer to Rate Rises, But Exact Timing Remains Unclear"

The Fed’s Own Stress Tests Aren’t as Stressful as Its Tests of Banks

Federal Reserve Chairwoman Janet Yellen was asked Tuesday on Capitol Hill who performs stress tests of the Fed. The question came from Sen. Tim Scott, a Republican from South Carolina, who said during a hearing of the Senate Banking Committee:
“On the issue of stress tests, I know that the Fed is, through the supervision of bank holding companies and other non-bank financial companies, the Fed conducts stress tests to determine how well the entity could withstand different levels of financial distress. The Fed currently has on its balance sheet about $4.5 trillion as a result of the QE program. Much larger than any of the financial entities it regulates. But it appears that nobody is stress-testing the Fed. The Proverbial Fox is guarding the hen house from my perspective.”
Ms. Yellen responded, “Well, with respect to our balance sheet, let me say that we do stress test it and we have issued some reports and papers where we describe what stress tests would look like when there are interest rate shocks, how that would affect our balance sheet and the path of remittances.” Over the course of three rounds of asset purchases, often called quantitative easing or QE, the Fed has acquired an enormous bond portfolio. The Fed has twice released a paper showing how that balance sheet would evolve under varying scenarios. But the Fed’s scenarios have not, typically, been as stressful as the scenarios that the central bank applies in its annual stress tests of the biggest U.S. banks.
In November 2012, the Fed tested the largest banks against one scenario in which 10-year interest rates climbed to over 3% by the middle of 2013 and above 5% by the end of 2015.
Continue reading "The Fed’s Own Stress Tests Aren’t as Stressful as Its Tests of Banks"

NY Fed Plumbs Balance Between Reverse Repos, Market Stability

A report released on Friday by the Federal Reserve Bank of New York highlights the balancing act the central bank faces as it prepares to deploy a new tool it hopes will provide better control over short-term interest rates. The report took stock of what the Fed calls reverse repurchase agreements, offering recommendations for the future that appear to be consistent with what policymakers already believe is appropriate. Through these instruments, the Fed takes in cash from eligible investment banks, money funds and others, in exchange for loans of Treasurys owned by the central bank. The Fed would pay interest on the cash and use that rate to set a lower boundary, or floor, for short-term rates in general. As the Fed has tested the tool since September 2013, and the new report says the results have been quite encouraging. The New York Fed offers a deep dive in to further refinements the Fed could make with the program. Some officials have become concerned the tool could pose a risk to financial stability. The main fear is that by providing a safe place to park money during times of stress, reverse repos could drain money out of private asset markets.  At the same time, some officials have worried the reverse repo program could cause some private financing markets to whither, displaced by a central bank taking in short-term cash. The Fed has already addressed some of those concerns. It has imposed total and firm-level borrowing caps, and it has signaled that the reverse repo program will be temporary. The paper’s authors conclude that a sizeable aggregate borrowing cap that shrinks over time could be worthwhile. Such a regime would give the Fed control over rates while signaling the supplemental nature of the program. The current overnight limit is $300 billion, periodically augmented by multiday term reverse repos. Continue reading "NY Fed Plumbs Balance Between Reverse Repos, Market Stability"

ECB’s Balance-Sheet Goal Takes a Hit

The ECB’s climb to €3 trillion just got a little steeper. According to the European Central Bank’s weekly update, its balance sheet—the value of assets it holds—fell by about €22 billion last week, settling at €2.03 trillion. This came despite new purchases of covered bonds under a new plan. The reason for last week’s drop: Banks paid back far more in ECB loans than the ECB bought in assets. At his most recent press conference, held last Thursday, ECB President Mario Draghi said that the ECB expects its latest measures, including four-year bank loans and purchases of covered bonds and asset-backed securities, to push the balance sheet back to early 2012 levels. Pressed for the specific period the ECB had in mind, Mr. Draghi responded March 2012, when the balance sheet was around €3 trillion. The size of the balance sheet is a rough proxy for the level of accommodation of the central bank. As the ECB buys more assets and lends more funds to banks, its balance sheet expands. It hopes in turn that these new funds are passed on to consumers and firms, who will invest, creating economic growth and raising inflation. Both these things desperately need to happen in the eurozone, and soon. The economy is stagnating and inflation is at rock-bottom levels, coming in at only 0.4% in October, way off of the ECB’s just-below-2% target. With balance sheets of the Federal Reserve and Bank of England stabilizing after they concluded their own asset-purchase programs, this also highlights the divergence between the ECB and other big central banks, which should cheapen the euro. But a big chunk of the ECB’s balance sheet—about €500 billion—is comprised of loans to banks. When banks pay these loans back, or opt not to borrow more from the ECB, the balance sheet shrinks. “The ECB has very little control over the size of its balance sheet,” said Lorcan Roche Kelly, an economist with Agenda Research in Ireland. The ECB really only controls what it buys on the open market, currently covered bonds and, soon, asset-backed securities. Its bank loans are dictated by demand, and the size of its targeted long-term lending programs are determined by banks’ lending. Moreover, until about March, as the ECB is issuing new four-year loans, banks are also repaying earlier three-year loans, offsetting the expansionary impact. If the balance sheet doesn’t start to grow in the next few months, it poses a “credibility problem” for the ECB, said Mr. Kelly, raising the likelihood that the central bank will need to widen its net of purchases to corporate bonds. He also said it could become a problem for the central bank should the balance-sheet volume drop below €2 trillion, which it is close to. “That’s a headline generator,” he said.  

Fed’s Axis of Opposition Shifts from Hawks to Doves

The Federal Reserve’s decision Wednesday to end its bond-buying program helped moved  the needle of formal opposition at the central bank from the camp of officials opposed to its ultra-easy credit policies to the group wanting them to continue for a long time to come.
Minneapolis Fed President Narayana Kocherlakota
For much of this year, the Fed officials known as hawks argued against the central bank’s efforts to hold interest rates very low to lower unemployment and spur growth. They didn’t like the pledge in the central bank’s policy statement to keep short-term rates near zero for a “considerable time” after the bond program ends, saying they expected to raise borrowing costs sooner than the phrase implied. They worried the wording suggested the decision on when to raise rates appeared linked to some time frame rather than the economy’s progress. And they were eager to end the bond-buying program, which sought to lower long-term rates. These policy makers see substantial improvement in the labor market and risks of higher inflation or financial instability if interest rates stay too low for too long. Philadelphia Fed President Charles Plosser and Dallas Fed President Richard Fisher both dissented at the Fed meeting in September because they objected to the “considerable time” language in the statement. Mr. Plosser also dissented at the July meeting. The two men did not dissent Wednesday, when the Fed ended the bond program and kept “considerable time” language but qualified it to emphasize that decision on when to raise rates would depend on the economy’s health. “The hawks got what they wanted,” said Ray Stone, economist with forecasting firm Stone & McCarthy Research Associates. “Not that anything big has changed, but Fisher and Plosser think things are moving gradually in their direction,” he said.  Meanwhile, the officials known as doves have supported keeping the “considerable time” language in the statement, worried that inflation is well below the Fed’s 2% target and forecast to stay there, inflation expectations are declining and the labor market remains weak in several ways. Some even want to make even stronger commitments to holding rates low for a long time, and have considered extending the bond-buying program. Minneapolis Fed President Narayana Kocherlakota cast the sole dissenting vote Wednesday, saying the Fed should promise to keep short-term rates near zero at least until inflation is forecast to reach 2% within one to two years, and it should continue the bond purchases. For Mr. Kocherlakota, any move toward rate increases is hard to swallow given the dearth of inflation in the U.S. economy. His dissent was his second this year. In March he opposed the Fed’s move to move toward vaguer guidance about the factors that would bring about an interest rate increase. The number of dissenting votes this year are on a par with those of the past few years, although they haven’t reached the near insurrection levels seen in 2011, when there were two Fed meetings with three dissents each. In some years, officials have seen dissents at every meeting. Mr. Kocherlakota is likely to find more reasons to object as the year comes to a close. Most Fed officials see rate increases arriving next year, with key officials favoring action in the middle of the year. The policy makers will be debating over coming months whether to keep their commitment to keep rates very low for a long time to come. Ending it would likely prompt Mr. Kocherlakota to dissent again, while pleasing the hawks. Next year’s voting roster of FOMC members could be a different story though. Leaders of the Chicago and San Francisco Fed banks gain votes, and they have been strong supporters of ultra-easy money policies. Balancing them is swing-voter Dennis Lockhart, president of the Atlanta Fed, and Richmond Fed President Jeffrey Lacker, an ally of those who want interest rate increases.  
Related Coverage
Fed Ends Bond Buys, Sticks to ‘Considerable Time’ on Rates Parsing the Fed: How the Statement Changed Read the Full Text of the Fed’s Statement End of QE3 Means Fed Statement Finally Shrinks Fed Signals Fiscal Policy No Longer Seen as Drag on U.S. Economy Economists React to the Fed Statement: ‘Surprisingly Hawkish’ The Fed Favors Guidance Over Bond Buys How Effective Were Fed Bond Buys? What the QE Research Says Grand Central: Fed Critics Have Been Wrong About QE’s Most Ill Effects Fedspeak Cheatsheet: What Are Fed Policy Makers Saying? Even if Fed’s Fisher and Plosser Dissent Again, They Won’t Catch Up To Henry Wallich Central Bank Watch, an interactive graphic

The Fed Favors Guidance Over Bond Buys

The Federal Reserve’s forward guidance has been a lot more effective at keeping long-term rates down and stimulating the economy than its three bond-buying programs, says Eric Swanson, an economist at the University of California, Irvine, who until recently was a researcher at the San Francisco Fed. The central bank’s expected decision Wednesday to end the bond-buying chapter of its response to the financial crisis and recession shows policy makers are sufficiently confident in the economic recovery to begin pulling back on their support for growth. At the same time, that confidence rests in part of the ongoing reliance on so-called forward guidance, currently the assurance, likely to be repeated in today’s policy statement, that the Fed will keep interest rates low for a “considerable time.” Such low-rate promises, says Mr. Swanson, who co-authored an influential paper on unconventional Fed policy with San Francisco Fed President John Williams early last year, have had a perceptible downward effect on borrowing costs.
San Francisco Fed President John Williams
Bloomberg News
“The cumulative effect of the Fed’s forward guidance has surely been much more important than the effect of its long-term bond purchases,” Mr. Swanson said in an email in response to questions from The Wall Street Journal. He estimates the Fed achieved only a fairly modest 0.1 to 0.2 percentage point decrease in short-term rates from its second round of bond buys, which amounted to $600 billion. “I think, going forward, the [Fed’s policy committee] views forward guidance as the better policy tool, which is why it’s comfortable winding down its long-term bond purchases now,” said Mr. Swanson, who was a senior research advisor at the San Francisco Fed and was previously a staffer at the Fed’s Washington-based board. Boston Fed President Eric Rosengren echoed that sentiment in an interview this month, when he argued the Fed’s first line of defense against any renewed deterioration in the economy, such as one stemming from recent weakness overseas, would likely be guidance, not asset purchases. “There are other tools that we can use. Staying at the zero lower bound for longer is one,” he said. The Fed has kept official interest rates near zero since December 2008, and bought over $3 trillion in mortgage and Treasury bonds in an effort to support the weakest economic recovery in decades.

The same approach favored by Mr. Rosengren holds for Mr. Williams, Mr. Swanson’s former boss at the San Francisco Fed. “If there was a significant decline in the outlook for growth or signs that inflation was not going to be moving back toward our 2% goal in the next couple of years, then the next stage in my thinking would be, to the extent that we can, to use forward guidance and communication tools about how the shift in the outlook would affect the appropriate path for policy, not only liftoff but also the pace at which we tighten,” he said in an interview this month.
Related Coverage
Fed Set to End QE3, but Not the QE Concept How Effective Were Fed Bond Buys? What the QE Research Says Grand Central: Fed Critics Have Been Wrong About QE’s Most Ill Effects Fedspeak Cheatsheet: What Are Fed Policy Makers Saying? Even if Fed’s Fisher and Plosser Dissent Again, They Won’t Catch Up To Henry Wallich Central Bank Watch, an interactive graphic

Grand Central: European Banks Pass Test, But Are They Ready to Lend?

Sign up for the newsletter: http://on.wsj.com/grandcentralsignup. HILSENRATH’S TAKE
The European Central Bank’s long-awaited asset quality review suggests the vast majority of Euro-area banks could withstand a shock to the region’s economy. Just 25 of 123 banks failed its stress test. That’s good news. But does it mean European banks are in position to start lending and fuel economic growth and investment? Probably not. Consider the path the U.S. has traveled. Long after its 2009 stress tests were completed and long after U.S. banks received and paid back government capital, bank lending in the U.S. was painfully slow to recover. Overall bank lending has grown at a modest 1.9% annual rate during this recovery and commercial and industrial loan growth has grown at a 3.6% rate. Only recently, five years after U.S. stress tests, have total bank lending and business lending started to pick up in earnest. In September total bank loans were up 6.3% from a year ago, the best performance since 2008, and commercial industrial loans were up a robust 12.3% from a year ago. There was plenty in the latest ECB stress test to leave observers wary about the broader health of European banks. Some big banks came close to failing, passing the test with ratios of capital-to-risky-assets not far above the 5.5% threshold in an adverse economic scenario. In Italy, where nine banks failed the tests, some of the country’s top lenders squeaked by, including UniCredit SpA, its largest bank, which came in with a capital ratio at 6.8% in an adverse scenario. In the U.K., two giant lenders that were bailed out by taxpayers during the crisis also passed with less than flattering results. Royal Bank of Scotland Group PLC and Lloyds Banking Group PLC showed capital below 7% in an adverse scenario. Some also looked shaky using other measures. The ECB said 17 banks would have been below a broad 3% leverage ratio. Based on the 4% threshold used by the Fed for big U.S. banks, 36 European firms would have fallen short. Read The Wall Street Journal’s complete coverage below.
  • By Jon Hilsenrath
MORNING MINUTES: KEY DEVELOPMENTS AROUND THE WORLD
ECB Says Most of Europe’s Banks are Healthy. Hoping to quell years of anxiety about Europe’s financial health, regulators said Sunday that all but 13 of the continent’s leading banks have enough capital to ride out another economic storm. The European Central Bank and the European Banking Authority announced the results of a nearly yearlong effort to assess the finances of 150 banks, identifying 13 that still need to come up with a total of €9.5 billion ($12 billion) in extra capital. Overall, 25 banks failed the so-called stress tests, facing a cumulative shortfall of €24.6 billion. More on the Stress Tests:
Full List of Banks that Failed
Interactive chart: A one-stop shop for European stress-test results.
ECB stress tests by country: How good were banks at valuing their own assets?
How the European Stress Tests Worked 
Heard on the Street: Europe’s Good-Enough Bank Stress Tests Fedspeak Cheatsheet: What Are Fed Policy Makers Saying? Federal Reserve officials approach the Oct. 28-29 Federal Open Market Committee meeting amid unsettled financial markets, weak inflation around the globe, and slowing economies outside the U.S. Most officials favor holding off on interest rate increases until next year and ending the central bank’s bond-buying as planned this month. Less clear is whether they will change the language in their policy statement saying they will keep interest rates near zero for a “considerable time.” Here’s a sampling of what Fed officials have said about the outlook for the economy and monetary policy since their meeting September 16-17. Janet Yellen’s August: Lots of Meetings — And Vacation. How does Fed Chairwoman Janet Yellen spend her August? Well, half of it on vacation, like much of the rest of official Washington. Ms. Yellen’s office recently released her calendar for August. Fed Board Meeting Again on ‘Medium-Term’ Issues. The Fed’s Board of Governors will hold a closed meeting Tuesday, with “Discussion of Medium-Term Monetary Policy Issues” on the agenda, according to an official notice. A two-day Federal Open Market Committee meeting starts the same day, and similar board meetings accompanied the central bank’s September, July, June and April policy meetings. This suggests Fed officials are continuing to discuss the tools they’ll use to eventually raise interest rates, even after releasing a “Policy Normalization Principles and Plans” statement last month. –Dow Jones Newswires BOJ Likely to Stick to Bullish Inflation View Despite Cutting Growth Forecast. The Bank of Japan will stick to its bullish inflation outlook when it meets this week, while likely taking a more bearish view on growth, people familiar with the central bank’s thinking say. Such an outcome would again underline the bank’s confidence that it can hit its 2% inflation target without taking any additional easing measures. BOC Chief’s Testimony Moved to Wednesday. Bank of Canada Gov. Poloz’s testimony to the Senate Banking Committee has been rescheduled to Wednesday and there won’t be a press conference by him until after his scheduled speech in Toronto on Nov. 3, say central-bank officials. Poloz’s quarterly presser after the BoC released its rate statement and monetary-policy report, as well as appearances in front of 2 parliamentary committees, were postponed after the fatal shooting of a soldier nearby shut down the capital Wednesday. –Dow Jones Newswires Sweden’s Riksbank Seen Cutting Main Rate. Sweden’s central bank is expected to cut interest rates to a new record low this week after inflation stubbornly refused to rise during the early autumn. Analysts polled by the Wall Street Journal said they think the Riksbank will lower its benchmark interest rate to 0.05% from a current 0.25%. The measure of underlying inflation most closely watched by the central bank came in at 0.3% in September, a full 0.4 percentage point below the Riksbank’s forecast, Nordea bank analysts noted.–Dow Jones Newswires GRAPHIC CONTENT
The U.S. housing market has struggled to find equilibrium after the bubble of the past decade. Here’s a look at where various gauges of supply and demand stand today. Explore the Journal’s interactive graphics — 10 in all — that look at volume of new- and existing-home sales, construction, value and prices, and supply.
FORWARD GUIDANCE
MONDAY
-Bank of Israel releases a policy decision at 4 p.m. local time
-BOE’s Shafik speaks in London at 1700 GMT
-ECB’s Nowotny speaks in Vienna at 1800 GMT TUESDAY
-Sweden’s central bank releases a policy decision at 0730 GMT
-Hungary’s central bank releases a policy decision at 1300 GMT
-BOE’s Cunliffe speaks in Cambridge, England at 1630 GMT
-Fed begins a two-day policy meeting in Washington WEDNESDAY
-BOE’s Haldane speaks in Birmingham, England at 1630 GMT
-Fed releases a policy decision at 2 p.m. EDT
-Brazil’s central bank releases a policy decision THURSDAY
-Reserve Bank of New Zealand releases a policy decision at 0900 local time
-BOE’s Cunliffe speaks in Bradford on Avon, England at 0645 GMT
-Fed’s Yellen delivers welcoming remarks at a Fed conference on diversity in economics in Washington at 9 a.m. EDT
-ECB’s Linde and Noyer speak at an event in Spain at 1815 GMT FRIDAY
-BOJ meets and releases its semiannual report on the growth and inflation outlook
-Bank of Russia releases a policy decision at 0930 GMT
-San Francisco Fed’s Williams speaks in Pretoria, South Africa at 9 a.m. local time (0700 GMT)
-San Francisco Fed’s Williams speaks on a panel about inflation targeting in Pretoria, South Africa at 3 p.m. local time (1300 GMT)
-Bank of Mexico releases a policy decision RESEARCH
Millions of Americans inadvertently made a classic investment mistake that contributed to today’s widening economic inequality: They bought high and sold low. Late in the stock market booms of the 1990s and 2000s, more U.S. families clamored into stocks as indexes surged. Then, once markets tumbled, many of them sold and took losses. Families that held on during the most recent stock collapses reaped the benefits as stocks nearly tripled between 2009 and today. New research from the Federal Reserve and the University of Michigan shows the role that panic about the market played in widening wealth inequality. Recent popular headlines seemed to suggest spending less on your wedding may help your marriage. Well, maybe. Two economists at Emory University — Hugo Mialon and Andrew Francis – looked into whether the cost of an engagement ring and wedding have anything to do with how long a marriage might last. That provoked a flurry of coverage that, well, sort of hit at what they said. But quickly lost in the debate was an age-old axiom: Just because two facts are related (cheap wedding, longer marriage) doesn’t mean one causes the other. COMMENTARY
Stress Tests Mark Important Step Toward Eurozone Banking Union, Simon Nixon writes in the Journal. “The success of this exercise hinges not on bank lending, but on whether it paves the way for the creation of a true eurozone banking union in which lenders are judged by their own creditworthiness rather than that of their governments. The creation of a single supervisor and a new common framework for winding down failed banks —based on the bailing-in of creditors at its core and access to a pan-European industry-financed resolution fund—will go some ways to breaking the toxic link between sovereign governments and banks.” What Europe’s Stress Tests Will and Won’t Do, Mohamed A. El-Erian writes for Bloomberg View, “Similar to efforts in the U.S. five years ago, the rigorous stress testing of banks in Europe is key to building a floor under the region’s economy and thus providing the basis for a more durable recovery. That is the good news in yesterday’s release of data by the European Central Bank. But for the assessment to be fully effective, Europe needs to do more, including finish work on the four legs of successful economic integration.”
Bond investors love “Ger-pan,” writes Alen Mattich in the Journal. “Germany is widely seen as the eurozone’s big winner, the flagship of growth while other economies sank into long term stagnation. Which makes it particularly worrying that the bond market thinks Germany looks a lot like Japan. The bond market is as good a summary of expectations about the future as there is. And it seems to be saying that Germany’s prospects are little different from Japan’s. In other words, that Germany is likely to spend years flirting with deflation and low growth. Out to five year maturities, yields on German government bills and bonds are below their Japanese equivalents. And for longer maturities, they’re not much higher.” BASIS POINTS
- Sales of newly built single-family homes in the U.S. rose 0.2% in September from the prior month to a seasonally adjusted annual rate of 467,000, the Commerce Department said Friday. SIGN UP: Grand Central, straight to your inbox. FEEDBACK LOOP: Send us your tips, suggestions and feedback. Write to: Jon.Hilsenrath@wsj.com; Victoria.McGrane@wsj.com; Pedro.daCosta@wsj.com; Michael.Derby@wsj.com; Nell.Henderson@wsj.com; Brian.Blackstone@wsj.com; jason.douglas@wsj.com; Ben.Leubsdorf@wsj.com; Paul.Hannon@wsj.com; Jacob.Schlesinger@wsj.com sarah.portlock@wsj.com Follow us on Twitter: @WSJCentralBanks, @NHendersonWSJ, @pdacosta, @Blackstonebrian, @PaulHannon29, @michaelsderby, @vgmac, @wsj_douglasj, @BenLeubsdorf, @JMSchels, @MargitFeher @NirmalaMenon @ToddBuell @sarahportlock

Lacker Prefers Fed Sell Mortgage-Backed Securities During Policy Exit

The Federal Reserve should sell its holdings of mortgage bonds as it tightens monetary policy, Richmond Fed President Jeffrey Lacker said Friday, so that it might move away from what he sees as the inappropriate allocation of credit to a specific sector in the economy. Mr. Lacker, considered an inflation hawk, has long been reluctant about the rapid expansion of the Fed’s balance sheet, which now stands at a towering $4.4 trillion. In particular, he has viewed the central bank’s interventions in the mortgage market through its massive purchases of real-estate linked bonds with great skepticism. “I cannot support the committee’s planned approach to moving the Fed’s balance sheet toward its normal state,” Mr. Lacker said in a statement. “The statement says that the committee currently does not anticipate selling agency mortgage-backed securities. I believe this approach unnecessarily prolongs our interference in the allocation of credit.” The Fed’s decision to buy MBS was driven in part by a crisis whose epicenter was housing. The central bank says it did not take on any credit risk in doing so because it only purchases mortgage bonds issued by government-sponsored enterprises. And policy makers believed a housing recovery was crucial to a broader economic rebound. Mr. Lacker disagrees. “The Fed’s statutory mandate of price stability and maximum employment would be best served, I believe, by a well-articulated plan to actively reduce our holdings of MBS through sales at a steady, predictable pace,” he said. This week, the Fed continued winding down its latest bond-buying program, signaling it would end in October. However, it also retained a promise to keep interest rates near zero for a “considerable time” after bond buys end, surprising investors who had been counting on some modifications to that language.    

Fed Revises Plans on How it Will Raise Rates

The Federal Reserve on Wednesday announced a revised plan for the mechanics of how it will raise interest rates from near zero when the time comes. As part of the so-called exit strategy, the Fed will continue to rely on its benchmark federal funds rate, an overnight interbank lending rate, as the key rate used to communicate Fed policy. The rate influences other borrowing costs throughout the economy, such as those on mortgages, car loans and credit cards. Raising it tightens credit: lowering does the reverse. But the primary tool for moving the fed funds rate will be the interest rate the Fed pays on the money, called excess reserves, that banks deposit at the central bank. The Fed also will use an interest rate it pays on trades called reverse repurchase agreements, or reverse repos, to help ensure the fed funds rate stays in its target range. The central bank has held the fed funds rate in a range between zero and 0.25% since December 2008 to help encourage businesses and consumers to borrow and spend. When the Fed makes its first rate increase, it will raise its target range for the fed funds rate. The Fed’s intention “has always been to return to a more traditional approach” after the extraordinary actions taken in recent years, Federal Reserve Chairwoman Janet Yellen said in a press conference. Those actions have included three rounds of bond-purchase programs aimed at stabilizing the financial system during the 2008 crisis and holding long-term rates low to spur stronger growth. She stressed the exit plan “is in no way intended to signal a change in the stance of monetary policy.” Many investors expect the central bank to start raising rates in the summer of next year, a view some top Fed officials have encouraged. The new plan “is meant simply to provide information about how the committee envisions the normalization process in light of the changes in economic and financial circumstances that have occurred since we put forth our original plans more than three years ago,” Ms. Yellen said. The exit plan followed the outlines the first released in July as part of the minutes of its June policy meeting. The new plan updates earlier efforts in 2011 and 2013 to lay out the manner in which the Fed can wind down its ultra-easy policy stance. The new plan reflects in part lessons learned as the Fed has experimented with new tools in a time when the banking system is flooded with reserves generated by the central bank. The reverse repo facility, in testing for a year, is open to banks and money-fund managers. It takes in cash from program participants in exchange for one-day loans of Treasury securities. Fed officials believe that rate they pay on that money will set a floor underneath short-term interest rates. The reverse repos have consistently generated strong interest on the part of market participants. But as the program has moved forward, there have been mounting worries it could cause financial instability. Some Fed officials have fretted the facility could pull money out of private short-term financial markets in times of stress, as market participants flee for the safe harbor provided by the Fed. Ms. Yellen said the reverse repos will be temporary, used only “to the extent necessary and will be phased out when no longer needed to help control the federal funds rate.” In another shift, Fed officials said they would wait until after they start raising rates before they wind down a program that invests the proceeds of maturing bonds into new securities. The Fed has been doing this to keep steady the size of its balance sheet—its total holdings of bonds and other assets. Those holdings are now worth about $4.5 trillion, up from less than $1 trillion before the 2008 financial crisis. The Fed also indicated it doesn’t plan to actively reduce its holdings through sales of securities. Instead, much of the contraction of the balance sheet back to historic levels will happen passively as its bonds mature. Ms Yellen said it could take until the end of the decade to bring the balance sheet back to more normal levels through this process.