Should Fed bond holdings be restricted?
By Scott Sumner
George Selgin has a new post discussing three pieces of legislation being considered by the Senate. Here’s one:
The Independence from Credit Policy Act (H.R. 4278), introduced by Rep. French Hill (R-AR), is intended to restrict the Fed’s asset holdings, apart from gold, foreign exchange, and IMF-issued SDRs, particularly by requiring it to swap its current MBS holdings for Treasury obligations. In future emergencies the Fed could temporarily acquire certain non-Treasury assets in connection with its 13(3) lending operations (concerning which see below); but it would be allowed to hold such assets for no more than a year, after which it would also have to trade them in for Treasury securities.
I have mixed feelings about this proposal. I would prefer the Fed hold Treasuries rather than mortgage backed securities, but I also worry about restrictions that might be perceived as limiting the ability of the Fed to hit its targets when at the zero bound. Here are a few provisions that could be added to this sort of bill:
1. The restriction on asset purchases could be limited to periods where the Fed holds less than 50% of Treasury securities outstanding. As far as I know, the Fed has never come close to that milestone, so the bill would still have exactly the effect its proponents hoped for, under all but the most unusual circumstances. But this provision would also make clear that the Fed never “runs out of ammunition” and hence make its policy commitments more credible.
2. I also think it would be helpful for legislation to spell out more clearly what Congress wants and expects from the Fed when at the zero bound. Thus Congress might want to instruct the Fed to do whatever it takes to achieve its Congressional mandate (currently stable prices and high employment, but I’d prefer stable NGDP growth.) Congress should tell the Fed that macroeconomic stability is far more important than any profits or losses on the Fed balance sheet. The Fed should be told that it is free to set the rate of interest on reserves at negative levels. (That’s assuming we keep IOR; I’d prefer the entire policy be abolished, as it has not worked well.)
Trying to keep the Fed focused on monetary policy rather than credit allocation is an entirely laudable goal. Indeed I might go even further, and recommend abolishing the discount window. But I also think we need to focus not just on limiting what the Fed can do, but also making it clearer that we want them to do whatever it takes to hit the more limited goals that we provide. We need less credit allocation and more macroeconomic stability.