06.16.2010 Policy Points

Unwinding Monetary Stimulus

An Economic Letter from the Federal Reserve Bank of San Francisco argues that the federal funds rate is likely to to remain near zero until 2012. From the letter …

The additional stimulus from the Fed’s unconventional monetary policy implies that the appropriate level of short-term interest rates would be higher than shown …. That is, conventional policy (the funds rate) can do less because of the stimulus to growth from unconventional policy. In calibrating this effect, it is important to note that changes in long-term interest rates have much larger effects on the economy than equal-sized changes in short-term interest rates….  If the Fed’s purchases reduced long rates by ½ to ¾ of a percentage point, the resulting stimulus would be very roughly equal to a 1½ to 3 percentage point cut in the funds rate. Assuming unconventional policy stimulus is maintained, then the recommended target funds rate from the simple policy rule could be adjusted up by approximately 2¼ percentage points … and the recommended period of a near-zero funds rate would end at the beginning of 2012.

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