MNI INTERVIEW: Fed Needs Better QE Guardrails- Fed Adviser

The Federal Reserve needs clear guardrails around how it uses quantitative easing in future amid heightened scrutiny over the limits of its legal powers and recent policy errors, Christina Skinner, who has advised the Fed and the Bank of England, told MNI.

With large-scale asset purchases becoming a more regular feature of monetary policy, Skinner said it would be a good idea to provide the same kind of framework that the Fed has given for meeting its inflation goal. The QE framework could cover things such as the potential stock and flow of asset purchases, the duration of any program and financial metrics for shifting to QT, she said.

“It seems easy to grow the balance sheet, very difficult to shrink it, and so if that in fact is true then QE is a little bit of a troubling one-way ratchet. That’s definitely something that central banks need to think about and explain,” said Skinner, assistant professor at the Wharton business school at the University of Pennsylvania.

More rules-based monetary policy could help the Fed deal with challenges to its legitimacy such as the risk of fiscal dominance, she said. While Chair Jerome Powell has come through former President Donald Trump's threat to fire him and persistent massive deficits, the Fed has been blamed for overdoing stimulus, misreading inflation as transitory and by some in Congress for the collapse of Silicon Valley Bank.

ACCOUNTABILITY DIAL WAY UP

“There are basically two reasons why Congress and the public sit up and pay attention to the central bank: either the central bank has made a mistake or they have done something that seems to push the limits of their authority and power, and both of those things are happening or have been happening at various intervals in the past three years,” Skinner said. “The accountability dial is turned up pretty high right now because the Fed and other central banks too are having to do a lot of self-reflection and explanation.”

Officials must also study whether they suffered from "groupthink" or economic modeling problems that caused a misreading of demand-side forces pushing inflation to its fastest rate in decades, Skinner said. “This is something that central banks need to explain across the board, and why I hope there will be more conversations about groupthink, diversity of viewpoint, and thinking through a broader array of modeling.”

The Fed's embrace of rapid interest-rate hikes is evidence that fiscal dominance never really took hold, she said. But dangers around political pressure are evident in calls for central banks to focus more on climate change or use balance sheets to underwrite other political pet projects. (See: MNI INTERVIEW: Fed Must Hike Rates To 6%, Maybe 7%-Ex-Staffer)

“That could eventually erode the legitimacy of the institution if people wake up one day and say we didn’t actually ask the central bank to allocate credit to green companies,” she said.

FINANCIAL STABILITY TRADEOFF

“What we had during Covid was fiscal-monetary coordination that got very close to fiscal accommodation. And if we had continued down that path then we might have flipped back into a world of fiscal dominance,” Skinner said. “The Fed’s actions over the past year in terms of raising rates is challenging for the government’s debt service burden. That is a show of independence.”

Higher borrowing costs create new tradeoffs around financial stability, another reason QE guardrails would help. The Fed's current "floor" model of controlling short-term rates is another area pointing to dangers from unchecked balance sheet expansion, Skinner said, echoing criticism from the BIS.

“The Fed has raised rates in the face of known financial stability, but it could be helpful if it articulated about how it thinks about the relationship between monetary stability and financial stability.”