| Posted by: Paul Donovan | Tags: Paul Donovan Weekly
The latest minutes from the US Federal Reserve discussed plans for Fed bond holdings. The Fed proposed that it will preannounce a schedule of tightening lasting several years, until policy is "normal". Every month, some maturing bond proceeds will not be reinvested. Every three months the Fed will tighten further.
Why is the Fed planning so far into the future? Perhaps the Fed wishes to avoid surprising financial markets. Politics may also play a role, however. Yellen's term as Fed chair and Fischer's term as Fed vice-chair both expire in 2018. There are vacancies on the FOMC. Congress has made suggestions that could undermine the policy independence of the Fed.
Quantitative policy is a normal instrument for a central bank, but in the wrong (politicized, non-economic) hands it is potentially very dangerous. The German Reichsbank's quantitative policy in 1923 had disastrous consequences; the German Reichsbank was run by a lawyer not an economist, so perhaps this is not surprising.
A preannounced quantitative policy tightening path gives insurance against the possibility (however remote) of a less independent Fed. If the current Fed schedules a complete quantitative policy normalization, it will be more difficult for a future Fed to change. The preannounced plan is a smart suggestion.
