William C Dudley: Panel remarks at the International Symposium of the
Bank of France
Remarks by Mr William C Dudley, President and Chief Executive Officer of the Federal
Reserve Bank of New York, at the International Symposium of the Bank of France "Central
Banking: The Way Forward?" Paris, 7 November 2014.
* * *
If all goes according to our forecast and the U.S. economy continues to make progress
towards the Fed's dual mandate goals of maximum sustainable employment and 2 percent
inflation, the Federal Reserve will likely begin to raise its federal funds rate target off the zero
lower bound sometime next year. For the United States, the start of the normalization of U.S.
monetary policy will be a very welcome development. It will indicate that the U.S. economy
has made great strides in healing itself from the damage caused by the U.S. housing boom
and bust, and the financial crisis.
However, this shift in policy will undoubtedly be accompanied by some degree of market
turbulence. Moreover, it could create significant challenges for those emerging market
economies (EMEs) that have been the beneficiaries of large capital inflows in recent years.
What can the Federal Reserve do to minimize these risks? These are some of the very
important issues raised by Helene Rey's work.
Let me begin by highlighting some of the key points I will be making. As always, the thoughts
I offer today are my own, and should not be interpreted as representing the position of the
FOMC or the Federal Reserve System.
First, what we may see in terms of market strains and macroeconomic adjustment during this
normalization process will not be new. Changes in Fed policy, and especially the tightening
of monetary policy, have often created challenges for countries abroad, especially in EMEs.
Second, these countries, as a group, are better equipped today to handle those challenges
than at perhaps any time in the past. This reflects the fundamental improvements and
stronger policy frameworks that many EMEs have put in place over the past 15 years. Third,
given the dollar's role as the global reserve currency, the Federal Reserve has a special
responsibility to manage U.S. monetary policy in a way that helps promote global financial
stability.
Like other central banks, our monetary policy mandate has a domestic focus. But, our
actions often have global implications that feed back into the U.S. economy and financial
markets, and we need to always keep this in mind. For most of us, the market volatility that
we saw during the so-called "taper tantrum" in the spring and summer of 2013 still remains
fresh in our minds. EME financial markets were hit hardest, with declines in equity prices, a
widening in sovereign debt spreads and a sharp increase in foreign exchange rate volatility.
In the U.S., we saw a spike in Treasury yields, with the 10-year rate rising by more than
100 basis points from early May before peaking in early September.
Most commentary about this period has focused on the shift in expectations with respect to
U.S. monetary policy - and, in particular, to uncertainty about the timing and implications of
Fed tapering - as the catalyst for these moves. This focus seems generally right to me,
although other factors also played a role.1
From one perspective, the unconventional nature of recent U.S. monetary policy adds little
that is fundamentally new to the challenges that face the EMEs. These policies simply
represent a way of easing, necessitated by our coming up against the zero lower bound.
Central bankers have managed differences across countries in cyclical positions and policy
stances many times in the past. This time should not be fundamentally different. But, from
another perspective, we have less experience operating with unconventional monetary
policy, and this creates more potential uncertainties. These uncertainties put a premium on
keen listening skills on our part and continued dialogue both among central bankers as well
as between central bankers and the market. In my view, it is important to recognize that our
large scale asset purchase programs affect the size of term risk premia globally. This new
set of monetary policies affects financial asset prices in a different way compared to changes
in short-term interest rates, and we should be humble regarding what we claim about our
understanding of the importance of this distinction.
Looking ahead, it seems likely that markets will remain focused on vulnerabilities that they
might have ignored prior to the taper tantrum in 2013. The greater premium on strong
fundamentals, policy coherence and predictability will likely remain. There will be no one right
answer in managing the trade-offs that come with the changed environment, and adjustment
will sometimes be difficult. Moreover, we will undoubtedly experience further bumps in the
road. The renewed volatility we saw last month is evidence enough of that. Yet, I think we
can remain generally optimistic on the outlook so long as market participants continue to
appropriately discriminate across countries, rather than treating EMEs as a homogenous
group.
Furthermore, many EMEs generally appear to be better equipped today to handle the Fed's
prospective exit from its exceptional policy accommodation than they were in past tightening
cycles. This reflects the fundamental reforms these EMEs have put in place over the past 15
years, as well as the hard lessons they learned from past periods of market stress. Among
the positives are:
• The absence of the pegged exchange rate regimes that often were undermined
violently in the past during periods of stress;
• Improved debt service ratios and generally moderate external debt levels;
• Larger foreign exchange reserve liquidity cushions;
Clearer and more coherent monetary policy frameworks, supporting what are now
•
generally low to moderate inflation rates;
Generally improved fiscal discipline; and
•
• Better capitalized banking systems, supported by strengthened regulatory and
supervisory frameworks.
Of course, progress has not been uniform across EMEs, and more work remains to further
strengthen institutional structures in some countries. In particular, vulnerabilities remain in
several important EMEs. Still, the fundamental improvements I've cited leave many EMEs
better positioned than in the past to weather those times in the cycle when the external
environment turns from welcoming to wary.
The impact that changes in Fed policy can have beyond our borders has led to calls for us to
do more to internalize those impacts, or even further, to internationally coordinate
policymaking. As I've already noted, Fed policies have significant effects internationally,
given the central place of U.S. markets in the global financial system and the dollar's status
as the global reserve currency. In pursuing our policy responsibilities, we seek to conduct
policy transparently and based on clear principles. We are mindful of the global effects of
Fed policy. Promoting growth and stability in the U.S., I believe, is the most important
contribution we can make to growth and stability worldwide.
There is, of course, the argument that Fed policy has been too accommodative for too long,
creating risks for financial stability worldwide. Here, I think it's important to consider carefully
the counterfactual. Would countries beyond our borders really have been better off with a
weaker U.S. economy? The fundamental issue is whether U.S. monetary policy has helped
support our dual objectives of stable prices and maximum sustainable growth, and whether
this support is consistent with a healthy global economy.
Moreover, it is far from clear that explicitly coordinated policy would produce better outcomes
for the global economy generally, or the EMEs specifically. Central banks have challenges
enough in tailoring policies to their own domestic circumstances. I believe that it would be
taking on too much to attempt to collectively fashion policy in reference to global conditions.
Monetary policy meant to suit everybody is likely in the end to suit nobody. Similar
considerations underlie the widespread move in the emerging world away from fixed
exchange rate regimes. Policymakers worldwide have learned that a framework capable of
responding in a disciplined but flexible manner to changing domestic conditions works best
over the long run.
While explicit coordination looks neither feasible nor desirable, there is more that central
banks in general, and the Fed in particular, could do to be better global stewards. As an
example, recent events demonstrate the importance of effective Fed communication. It is
clear in retrospect that our attempts in the spring of 2013 to provide guidance about the
potential timing and pace of tapering confused market participants. In particular, markets
seemed to conflate tapering with monetary policy tightening and raised their expected paths
for policy rates. Lately, we seem to have done better: markets now seem to understand that
policy rates will likely remain exceptionally low for a considerable period of time even now
that the asset purchase program has been completed.
As you know, we've taken a number of steps in recent years to increase transparency and
improve our communications. This includes regular press conferences following Federal
Open Market Committee (FOMC) meetings by the Fed chair; the publishing of growth and
inflation forecasts of FOMC participants; and a concerted attempt to lay out the guideposts
that the FOMC will look at to assess progress toward our mandate. We are, though, still
learning how to more effectively communicate, especially given our new and expanded set of
policy instruments.
A second area in which we can and must do better is safeguarding financial stability. Simply
put, we failed to act both early enough and decisively enough to stem the credit excesses
that spawned the financial crisis and the Great Recession. The U.S. was not alone in this
shortcoming, but given our position in the global financial system, we especially should have
done better. We've taken important steps reflecting both new legislative mandates and a
broader effort to rethink our regulatory and supervisory framework. In particular, systemically
important banking organizations must now hold amounts of capital and liquidity that are
better aligned with their risk profiles, compensation schemes for these institutions will be
more focused on rewarding long-term results and the official sector is making progress in
solving the "too-big-to-fail" dilemma.
All of this remains very much a work in progress. But, these efforts should help us to avoid
repeating the mistakes of the recent past, and to take a more proactive stance toward
mitigating potential future vulnerabilities. Of course, we at the Fed are not alone here. Since
the recent financial crisis, central banks worldwide have been engaged in a broad rethinking
of how to better fulfill their mandates.
Let me close with a final thought. The largest problems that countries create for others often
emanate from getting policy wrong domestically. Recession or instability at home is often
quickly exported. Equally important, growth and stability abroad makes all our jobs easier.
This means that there are externalities in the work we do, so that more effective fulfillment of
our domestic mandates helps to bring us to a better place collectively. Ensuring global
growth and stability is and will remain our joint and common endeavor.