Making sure the financial system is robust and resilient is probably the most important thing the central bank can do in this respect. I would like to turn now to the issue of how the initial step in normalization is going. The U.S. bond market response to lift-off has been very mild. There has been no bond market “taper tantrum” such as what occurred in 2013 when Chairman Bernanke discussed the possibility of tapering Federal Reserve asset purchases. Normalization is also going very well in the sense that, even with an extraordinarily large balance sheet, the tools we have developed to raise the federal funds rate (and other money market rates) have so far worked well. The federal funds rate is trading close to the middle of the new target range of 25 to 50 basis points and other money market rates have moved up in tandem. Why is this noteworthy? To explain, I’ll first have to provide some background on how monetary policy used to work before the crisis and then compare that regime with how it works now. 4  BIS central bankers’ speeches  Before the financial crisis, banks valued reserves – even though the Federal Reserve paid no interest on them – because the Federal Reserve kept their supply scarce.
Second, the first tightening move might itself provoke another taper tantrum characterized by higher bond yields and tighter financial market conditions that could be sufficiently strong to impede the economic recovery. My judgment was that these risks were manageable. First, downside forecast errors are certainly possible, but the U.S. economy appears to be on sufficiently sound footing to withstand downside shocks better than was the case a few years ago. Second, I felt that the likelihood of a substantial tightening in financial market conditions due to lift-off was relatively low, in part, because the rate hike was widely anticipated. Market conditions had adjusted quite smoothly – except for some strains observed in the high-yield debt market – as market participants placed higher odds of tightening in the weeks preceding the December FOMC meeting. This reinforced that conclusion. A large market reaction would have been a surprise given that this was one of the most anticipated monetary policy events in history. Also, the policy action needs to be viewed in context. While this decision was the first upward adjustment BIS central bankers’ speeches  3  to short-term rates in nearly 10 years, the actual move was small – only 25 basis points – which, by itself, should have only a very mild impact on the overall trajectory of the economy. As we noted in the FOMC statement and as Chair Yellen pointed out in her December press conference, even after this rate hike, the stance of monetary policy remains accommodative.