In my remarks, I am going to focus only on the set of unconventional monetary policies that are relevant today in an environment in which central banks are constrained from lowering their policy rate any further due to the zero lower bound. I will not discuss the type of extraordinary interventions that occurred at the height of the financial crisis.1 A starting point is that the independence of the central bank with respect to its budget supports its overall independence. The Federal Reserve’s traditional monetary policy framework has helped to assure this budgetary independence. The liability side of our balance sheet consisted primarily of currency and reserve balances on which we did not pay any interest. The asset side consisted primarily of Treasury securities. There was no meaningful credit risk and the interest rate risk was limited because assets were generally held to maturity. This, combined with the zero cost of the Fed’s liabilities, resulted in the Federal Reserve turning over a large amount of earnings to the Treasury each year after covering all of its operating costs and retaining a small portion of its earnings to maintain a level of surplus capital equal to the amount of capital paid-in by member banks. Thus, one key question is how this budgetary independence might be threatened through the use of unconventional monetary policies. After all, some of these policies do have implications for the Federal Reserve’s remittances to the Treasury and, thus, could conceivably create a potential threat to the Federal Reserve’s budgetary independence.
Providing a forecast for the policy rate by itself does not create any budget or reputational risk for the Federal Reserve, so I generally do not see the first form of forward guidance as posing much risk to central bank independence.2 The second form of forward guidance – pre-commitment to a policy rate path – could create more risk for the central bank. In particular, consider a scenario in which the central bank decided to increase monetary accommodation by committing to maintain a low short-term interest rate for a long time even if this commitment resulted in inflation overshooting the central bank’s objective in the future. I could see how this could create a potential threat to the central bank’s independence. That is because the commitment could force the central bank in the future to conduct monetary policy in a way that was inconsistent with the inflation portion of its mandate. Although this second form of forward guidance could create greater risk for the central bank with respect to its future independence, this is not a policy that has been adopted by the Federal Reserve. There are implementation challenges with this approach. In particular, it is difficult for a monetary policy committee today to institutionally bind future monetary policy committees to follow actions that could conflict with their objectives in the future. Without such a credible forward commitment, such policies would likely be ineffective in affecting expectations in the manner needed to provide additional monetary policy accommodation.