Kansas City chief suggests Fed should announce desired reserve levels as balance sheet shrinks.
Kansas City Fed President Esther George Friday said the case for continuing to remove policy accommodation is clear but argued for a steady path over speed, while warning uncertainty about the tightening pace contributes to market volatility that could be important amid balance-sheet runoff.
"With the policy rate still relatively low, the balance sheet still near $9 trillion, and imbalances in the economy still holding up inflation, the case for continuing to remove policy accommodation remains clear-cut," she said. "The key questions are by how much and how quickly."
"Given the likely lags in the pass through of tighter monetary policy to real economic conditions, this argues for steadiness and purposefulness over speed," she said.
Economic constraints revealed by the pandemic are likely to be around for some time George said, contributing to inflation and requiring a sustained policy response. "The widespread nature of inflation suggests that a tight economy is driving price pressures rather than solely individual supply disruptions and shocks," she said. The obstacles also include abysmal recent productivity and long-lasting damage to workforce engagement and labor force participation, she said. (See: MNI INTERVIEW: US Labor Force 'Missing' 2.5M Workers - KC Fed)
Weighing in on the peak policy rate is speculation at this point, she said in prepared remarks, and the Fed will have to determine policy through observation rather than theoretical models or pre-pandemic trends.
"To the extent that the strains in the Treasury market can be attributed in part to heightened uncertainty about the path of policy rates, a steady path of rate increases and predictably adjusting this path to incoming data could improve market functioning and facilitate balance sheet runoff," she said.
George also pointed to a Jackson Hole paper in saying reducing the central bank's balance sheet could prove difficult. Avoiding the threat of banks adjusting their business models around a high level of central bank liquidity, the Fed will need to clearly signal its resolve to shrink the balance sheet, she suggested.
"There may be benefits to announcing the desired reserve levels as the balance sheet shrinks, giving banks time to prepare to operate with significantly fewer reserves," she said in a speech at a Peterson Institute for International Economics event.