william c dudley : unconventional monetary policies and central bank independence remarks by mr william c dudley, president and chief executive officer of the federal reserve bank of new york, at the bank of mexico international conference “ central bank independence – progress and challenges ”, mexico city, 15 october 2013. * * * it is a pleasure to be here today. does the implementation of unconventional monetary policies pose a threat to central bank independence? my short answer, which i will elaborate on, is that while the threat is low, central bankers need to be cognizant of such risks, and clearly explain the motivations for their actions in order to mitigate such risks. the best way for central banks to maintain their independence is to use all their available monetary policy tools to best achieve their objectives. because the use of our unconventional monetary policy tools has been in pursuit of our dual mandate objectives of maximum sustainable employment in the context of price stability, i do not see the use of these tools as creating significant new risks to our independence. as always, what i have to say today reflects my own views and not necessarily those of the federal open market committee or the federal reserve system. to start, it is important to be clear on what we mean by unconventional monetary policies. in my remarks, i am going to focus only on the set of unconventional monetary policies that are relevant today in an environment in which central banks are constrained from lowering their policy rate any further due to the zero lower bound. i will not discuss the type of extraordinary interventions that occurred at the height of the financial crisis. 1 a starting point is that the independence of the central bank with respect to its budget supports its overall independence. the federal reserve ’ s traditional monetary policy framework has helped to assure this budgetary independence. the liability side of our balance sheet consisted primarily of currency and reserve balances on which we did not pay any interest. the asset side consisted primarily of treasury securities. there was no meaningful credit risk and the interest rate risk was limited because assets were generally held to maturity. this, combined with the zero cost of the fed ’ s liabilities, resulted in the federal reserve turning over a large amount of earnings to the treasury each year after covering all of its operating costs and retaining a small portion of its earnings to maintain a level of surplus capital equal to the amount of capital paid - in by member banks. thus, one key question is how this budgetary independence might be threatened through the use of unconventional monetary policies. after all, some

is not a policy that has been adopted by the federal reserve. there are implementation challenges with this approach. in particular, it is difficult for a monetary policy committee today to institutionally bind future monetary policy committees to follow actions that could conflict with their objectives in the future. without such a credible forward commitment, such policies would likely be ineffective in affecting expectations in the manner needed to provide additional monetary policy accommodation. in contrast, i think there are greater potential risks to central bank independence from the fed ’ s large - scale asset purchase programs and the treasury maturity extension program. these programs do create some budget risk for the federal reserve. the issue here is not that the fed is taking credit risk because the fed ’ s purchases are restricted to treasuries and agency mbs. instead, the budgetary risks stem from the fact that these asset purchase and maturity extension programs expose the federal reserve to increased interest rate risk that could affect the level of net interest earnings and therefore the amount of the fed ’ s remittances back to the u. s. treasury. if the federal reserve needed to raise short - term rates to attain its objectives, it would do so by raising the interest paid on its reserves. as a result, net interest earnings would fall due to the increase in interest cost. if the rise in rates were sufficiently large, the federal reserve ’ s net interest margin could turn negative, resulting in losses for the federal reserve. the fed ’ s earnings could also be adversely affected by asset sales. for example, if the fed determined that it needed to reduce the aggregate level of reserves through asset sales, the fed might incur losses by selling these assets at prices below their amortized costs. although this risk is real, i believe it is not a big threat to the federal reserve ’ s independence for two reasons. first, the potential for this outcome is mitigated by the fact that the federal reserve has considerable non - interest bearing liabilities on its balance sheet – namely currency. these liabilities incur no interest expense regardless of the stance while i have categorized providing a forecast for the future path of the policy rate as a form of unconventional monetary policy, this may be a misnomer in that some central banks use this form of forward guidance as part of their standard communication strategy, and the federal reserve may choose to continue to provide this form of forward guidance even after its policy rate is no longer constrained by the zero lower bound. bis central bankers ’ speeches of monetary policy