By Michael S. Derby
NEW YORK, Sept 22 (Reuters) – New York Federal Reserve President John Williams defended the US central bank’s monetary policy implementation system on Tuesday, while saying it can be adjusted and tweaked in line with changes in financial markets.
Supplying “ample” reserves to the financial system with the current suite of tools to manage short-term interest rates “has proven to be highly effective at delivering interest rate control and supporting the smooth functioning of core financial markets,” Williams said in prepared opening remarks for a conference on the Treasury market at the New York Fed.
Williams did not address the outlook for monetary policy or interest rates in his remarks and he was not scheduled to take questions following his speech to the conference.
The New York Fed chief said that while the central bank’s rate-control framework has worked well, it is not set in stone and can be adapted to changing market conditions.
“As markets evolve over time, we must ensure that policy tools are fit for purpose to carry out their necessary functions,” Williams said. “Put simply, the evolution of financial market structure leads to the evolution of how we carry out monetary policy effectively.”
DEBATE OVER BALANCE SHEET
Williams made his remarks on the mechanics of how the Fed manages short-term interest rates to achieve its inflation and employment mandates as the central bank is reflecting on a range of issues.
The central bank under new Fed Chairman Kevin Warsh has a series of task forces looking broadly at how it communicates, evaluates data and deals with its still large balance sheet. Warsh, before taking over as Fed chief in May, routinely criticized the central bank for its large asset holdings and system of providing substantial liquidity to the financial system in the form of reserves.
Before the 2008 financial crisis, the Fed kept liquidity tight in financial markets, but that approach was abandoned.
Fed officials have argued for some time that keeping strong amounts of liquidity in the system helps promote financial stability. They have also said the tools the central bank uses to manage liquidity enable strong control over short-term rates, which is the critical issue in the entire debate.
“There should be little or no opportunity cost to holding reserves at the central bank,” Williams said. “A high opportunity cost is simply inefficient and creates other distortions that interfere with market functioning and stability.”
Williams, however, noted that the Fed’s strategy will be responsive to market conditions.
“If underlying demand for reserves shifts due to changes in regulation, market structure, or any other reason, the Federal Reserve will match that with a shift in the supply of reserves over time,” he said.
(Reporting by Michael S. Derby; Editing by Paul Simao)
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