德意志银行美国经济USEconomicPerspectivesTheFedsevolvingview

13July2017USEconomicPerspectivesNorthAmericaUnitedStatesEconomicsUSEconomicPerspectivesDate13July2017DeutscheBankResearchTheFed'sevolvingviewsonfinancialconditions■Inrecentweeks,variousformsofFedcommunicationhaveindicatedsomediscomfortwithelevatedriskassetvaluations,compressedriskpremia,andaneasingoffinancialconditionsevenastheFedhasraisedrates.TheimplicationhasbeenthateasingfinancialconditionsandrelatedfinancialstabilityconcernsmaybeanadditionalconsiderationthathelpstokeeptheFedonitstighteningpathinthecomingquarters.■Ratherthanviewingthesestatementsasaone-offresponsetoauniquemacroandfinancialbackdrop,thereareatleasttworeasonswhyfinancialconditionsandfinancialstabilityconsiderationsarelikelytoplayamoreimportantroleinmonetarypolicydecisionsintheyearstocome.First,lowpolicyratesrequireunconventionalmonetarypolicyresponses,whicharelikelytomakeperiodsofbroadriskpremiumcompressionandelevatedriskassetvaluationsmorelikelyinthefuture.Second,lowpolicyratesimplythatcentralbankshavelessroomto“cleanupthepieces”fromapoppedbubble,makingpreventivemeasures,suchaspolicyrateincreases,moreappropriateonthemargin.ThismoreactiveroleformonetarypolicywouldmarkadeparturefromtraditionalFedviews.■Wetakeamodestfirststepintryingtooperationalizehowmonetarypolicyshouldrespondtofinancialconditionsinlightofthispotentialre-thinkbytheFed.Specifically,weconstructasimplemodifiedTaylorrulethataccountsformovementsinfinancialconditionsascapturedbyourDBfinancialconditionsindex(FCI).Thismodifiedpolicyrulecanattimesleadtomeaningfullydifferentprescriptionsthantraditionalpolicyrules.Forexample,currentfinancialconditions,whichareneartheloosestlevelssince2014,wouldaddnearly40bptoatraditionalTaylorruleprescription.WealsodetailseveralhistoricalepisodeswheretheFCI-augmentedruledivergesfromtraditionalpolicyruleprescriptions.■Finally,weprovideahistoricalaccountoftheevolutionofFedthinkingabouthowmonetarypolicyshouldrespondtofinancialstabilityconsiderations,fromthetraditionalviewthatmonetarypolicyhasonlyalimitedrole,tothemorerecentdebatewhichallowsforasomewhatmoreactiverole.MatthewLuzzetti,PhDSeniorEconomist+1-212-250-6161DeutscheBankSecuritiesInc.DISCLOSURESANDANALYSTCERTIFICATIONSARELOCATEDINAPPENDIX1.MCI(P)083/04/2017.Distributedon:13/07/201713:21:06GMT0bed7b6cf11c13July2017USEconomicPerspectivesIntroductionInrecentweeks,variousformsofFedcommunication–fromcommentsbyYellen,Fischer,Dudley,andWilliams,totheminutesfromtheJuneFOMCmeetingandthesemi-annualMonetaryPolicyReport–haveindicatedsomediscomfortwithelevatedriskassetvaluations,compressedriskpremia,andaneasingoffinancialconditionsevenastheFedhasraisedrates.TheimplicationhasbeenthateasingfinancialconditionsandrelatedfinancialstabilityconcernsmaybeanadditionalconsiderationthathelpstokeeptheFedonitstighteningpathinthecomingquarters.Importantlyformarkets,wethinkthattheheightenedfocusonfinancialconditionsislikelytobecomeamorepermanentfeatureoftheglobalcentralbanklandscapeforatleasttworeasons.First,lowrealneutralrates(r-star)requireunconventionalmonetarypolicyresponses,includinglowandnegativerates,quantitativeeasing,andenhancedforwardguidance,whicharelikelytoinducehigherdegreesofrisktaking.1Consequently,periodsofbroadriskpremiumcompressionandelevatedriskassetvaluationsaremorelikelyinthefuture.Second,theproximitytothezerolowerboundimpliesthatcentralbankshavelessroomto“cleanupthepieces”fromapoppedbubble.Asaresult,thetraditionalFedstancethatitismostappropriatetoeasepolicyifandwhenabubblepopsislikelytobelesseffective,makingpreventivemeasures,suchaspolicyrateincreases,moreappropriateonthemargin.Ifwearerightthatfinancialstabilityconsiderationswillremainamorepermanentfocusofcentralbankers,itisusefultohaveaframeworkforquantifyinghowmonetarypolicyshouldbecalibratedtoaccountforfinancialconditions.WetakeamodestfirststepinthisdirectionbyconstructingasimplemodifiedTaylorrule–anFCI-augmentedrule–thataccountsformovementsinfinancialconditionsascapturedbyourDBfinancialconditionsindex(FCI).Tosummarizeourconclusions,ourhistoricalanalysiscomparingtheFCI-augmentedruletoatraditionalTaylorruleandtheFed’sactualpolicydecisionsuncoversthefollowing:■Financialconditionswouldmatter:TherearetimeperiodswhenaTaylorruleaugmentedtoaccountforfinancialconditionsprovidesmateriallydifferentpolicyrateprescriptionsthanastandardpolicyrule.■Currentpolicy:Easyfinancialconditions,whichareneartheloosestlevelssince2014,wouldaddnearly40bptoatraditionalTaylorruleprescription.■TheFedwasrighttoundertakesteepratecutsduringthe2000-2003period:RelativetoastandardTaylorrule,whichimpliesthattheFedcutratestooaggressivelyintheearly2000s,theFCI-augmentedrulesupportsthedegreeofFedcutsduringthisperiodduetotightfinancialconditions.■TheFedshouldhaveraisedratesmoreaggressivelyduringthehousingboom:Despitesupportingmoreextremecutsthrough2003,thefedfundsrateimpliedbytheFCI-augmentedrulerisesaboveatraditionalTaylorrulebylate2003andprescribesafedfundsratebetween4.5-5%through1Thisviewisnotnew,anditisperhapsbestarticulatedinaspeechbythenMinneapolisFedPresidentKocherlakota.See:Kocherlakota,Narayana(April18,2013),Lowre