BIS central bankers’ speeches  5  Second, during the financial crisis, especially during the fall of 2008, financial market conditions tightened dramatically even as the FOMC was cutting its federal funds rate target to zero. Monetary accommodation turned out to be insufficient to produce an easing of financial market conditions, and the economy fell into a deep recession. Over time, financial market conditions have become a much more important factor in evaluating the appropriate setting of monetary policy and the level of short-term interest rates. This reflects several factors. First, over the past few decades, as the U.S. capital markets have grown in size and scope, the U.S. financial system has become much less bank-centric. This has loosened the linkage between the federal funds rate and financial market conditions. Second, the U.S. economy and financial markets have become more interconnected globally. Thus, the impact of U.S. monetary policy has become more diffused, and financial market conditions have come to depend increasingly not only on developments in the U.S., but also on developments elsewhere. As an example, the low level of U.S. 10-year Treasury yields presumably is due, in part, to the fact that long-term interest rates in Europe and Japan are much lower. So, if the effect of short-term rate changes on financial market conditions has become less predictable and more variable over time, what implications does this have for U.S. monetary policy? From my perspective, there are three major implications that deserve attention.
This will cause major oil exporters to run either smaller budget surpluses or bigger budget deficits. In the aggregate, the swing from oil producers to consumers is quite large. For example, a $ per barrel decline in global oil prices results in an income transfer of about $ billion per year from producers to consumers.2 This understates the total effect because it does not include any knock-on reductions in other energy prices – such as for natural gas – that, outside the U.S., often are linked to oil prices. Obviously, if the oil price declines were to both intensify and persist, this would have negative implications for oil and gas investment in the U.S. At a minimum, as cash flows fall, some producers will cut back on their drilling activity rather than plug the shortfall with outside financing. Nevertheless, there are several reasons why I don’t think this risk should be overstated, especially if oil prices stabilize around current levels. First, even after the large gains in recent years, oil and gas investment remains a small fraction of GDP. Second, domestic natural gas investment should be relatively unaffected because U.S. natural gas prices are largely insensitive to global energy price developments. This reflects the high costs associated with exporting natural gas and the fact that most of our oil production is used for transportation purposes. Thus, the ability to substitute lower cost natural gas for oil is limited. Third, extraction costs vary appreciably across the different major oil fields.