Federal Reserve 'Ramps Up' Debate Over Taper Timing

Jul. 22, 2021 6:20 PM ET31 Comments
John M. Mason profile picture
John M. Mason
15.83K Followers

Summary

  • More and more Fed officials seem to be uncomfortable with the Fed's current time schedule for scaling back its easy-money policy.
  • Fed Chair Jerome Powell continues to set the tone of the discussion, focusing on the possibility that inflationary pressures will dissipate, because they are temporary in nature.
  • But, the Fed has sold more than $1.0 trillion in securities under an agreement to repurchase them over the past six months, countering the security-purchase program.
  • The debate over "tapering" seems to be picking up and will probably result in a change in monetary policy earlier than now is anticipated.

Assistance
chaofann/iStock via Getty Images

Nick Timiraos writes in the Wall Street Journal that

"Federal Reserve officials are set to accelerate deliberation at their meeting next week over how to scale back their easy-money policies amid a stronger U.S. economic recovery than they anticipated six months ago."

"Fed Chairman Jerome Powell has said their discussions are focusing on two important questions: When to start paring their monthly purchases of $80 billion in Treasury securities and $40 billion in mortgage securities and how quickly to reduce, or taper, them."

To me, this discussion is somewhat distracting.

Fed Chairman Jerome Powell wants to keep the focus on the monthly purchases of Treasury securities and mortgage securities.

To me, Fed Chairman Jerome Powell wants to direct attention away from something else that the Federal Reserve has been doing over the past six months.

I have just written about this in a Seeking Alpha post titled "The Real Pressure On The Fed."

Fed's Use Of Reverse Repurchase Agreements

In this article, I discuss how the Fed has used reverse repurchase agreements to remove reserves from the banking system at the same time that it is adding reserves to the banking system through the $120 billion in securities purchases every month.

As I write in the cited article, beginning early in February 2021, the Federal Reserve has been engaging in reverse repurchase agreements in order to keep short-term interest rates, like its policy rate of interest, the Federal Funds rate from becoming negative.

On February 2, 2021s, the Fed had only $209 billion in reverse repurchase agreements on its balance sheet. This number was around the amount the Fed worked with over the past year or so.

But, the numbers began to increase after this date. By June 30, 2021, the total had moved up to $1,261 billion of reverse repurchase agreements on its balance sheet. That is $1.3 trillion!

Note, that before the Great Recession began in late 2007, $1.3 trillion was about one and one-half times the total amount of assets that the Fed had on its balance sheet. This is a massive amount!

My hypothesis is that it was necessary to remove these funds from the banking system in order to keep the Fed's policy rate of interest in positive territory, a Fed objective.

The Falling Federal Funds Rate

The effective Federal Funds rate had been resting around 0.09 percent up until January 9, 2021. As mentioned above, the Fed began using more reverse repos early in February.

The effective Federal Funds rate was 0.08 percent until February 17 and then dropped to around 0.07 percent until April 28.

And. this was with the Federal Reserve taking massive amounts of reserves out of the banking system through the reverse repos.

On June 16, the effective Federal Funds rate rose to 0.10 percent.

Whew!

This was after about $1.0 trillion reserves were taken out of the banking system during this six-month period.

And, yet the Fed was still buying $120 billion in U.S. Treasury securities and mortgage securities each month.

Going Forward

Now we get back to the picture Mr. Timiraos is writing about.

What is the Federal Reserve going to do?

It looks as if the monthly purchases are sufficient to drive the Federal Funds rate below zero, if nothing else is done. It has taken a massive effort on the part of the Fed, using reverse repos, to keep the Federal Funds rate as high as 10 basis points.

But Mr. Timiraos writes that Fed officials "aren't likely to consider raising interest rates from near zero until they are don tapering the asset purchases."

"Some officials have discussed concluding the purchases around October 2022 so they could lift rates later that year if the recovery is stronger or inflation is higher than now anticipated."

But, how is the Fed going to get out of its current dilemma?

The Future Of The Economy And Inflation

Mr. Powell, and other Fed officials, have based their current stance upon the belief that the rising inflation numbers will reverse themselves in a few months, returning to rates that are closer to the Fed's goals of 2 percent inflation.

They argue that the current situation has been created by short-run factors, like supply chain problems, that are just temporary and will be worked out in the near future.

Because of this, they contend that the Fed can continue to acquire the $120 billion of securities each month because the U.S. economy needs the stimulus.

The interest rate situation must also be looked upon as a temporary disturbance, one that will be reversed in the near future.

If the pressure for these rates to fall reverses itself, then the Fed can just let the reverse repurchase agreements to "run off" and no one will be worse off for the Fed's massive injection of reserves into the money markets.

The problem I see is that even though the economy and inflationary pressures moderate, there still is the problem that so much liquidity around, with more coming in future monthly securities purchases, that short-term interest rates will continue to be under pressure to move into negative territory.

This, to me, is what more and more Fed officials are worried about keeping up the purchases. These purchases must slow down and must eventually stop for the short-term rates to stay in positive territory.

But, the Fed officials are still not talking about this issue.

Inside Turmoil

Mr. Timiraos writes

"Mr. Powell faces more division among Fed officials over the outlook and the proper policy response than at any time since the pandemic forced the central bank to cut rates last year."

"At their June 15-16 policy meeting, 13 of 18 Fed officials projected they would raise rates by the end of 2023; seven expected to do so by the end of 2022."

The action point keeps moving up. And, the number of Fed officials wanting it moved up, keeps increasing.

But, the questions asked earlier are still very relevant. When might the change take place? And, how will the change take place?

If the Fed continues to purchase $120 billion in securities every month to increase bank reserves and the Fed continues to sell securities (under an agreement to repurchase them) in large amounts, it would seem that a point will be reached when Fed officials find this effort to be counter-productive.

Then, maybe we will get a change in policy. Mr. Timiraos indicates that Fed officials are becoming more and more uncomfortable with the way the Fed is now functioning. Might the change come sooner than expected?

This article was written by

John M. Mason profile picture
15.83K Followers
John M. Mason writes on current monetary and financial events. He is the founder and CEO of New Finance, LLC. Dr. Mason has been President and CEO of two publicly traded financial institutions and the executive vice president and CFO of a third. He has also served as a special assistant to the secretary of the Department of Housing and Urban Development in Washington, D. C. and as a senior economist within the Federal Reserve System. He formerly was on the faculty of the Finance Department, Wharton School, the University of Pennsylvania and was a professor at Penn State University and taught in both the Management Division and the Engineering Division. Dr. Mason has served on the boards of venture capital funds and other private equity funds. He has worked with young entrepreneurs, especially within the urban environment, starting or running companies primarily connected with Information Technology.

Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Recommended For You

Comments (31)

To ensure this doesn’t happen in the future, please enable Javascript and cookies in your browser.
Is this happening to you frequently? Please report it on our feedback forum.
If you have an ad-blocker enabled you may be blocked from proceeding. Please disable your ad-blocker and refresh.