Yellen’s Balance Sheet Baloney

By George Selgin

Of the many questions reporters asked Janet Yellen on Wednesday, at her press conference following the FOMC’s decision to raise the Fed’s policy rates, my favorite was the very first, posed by the Financial Times‘ U.S. Economics Editor, Sam Fleming.

Here is Mr. Fleming’s question:

[You’ve stated that the Fed wants to delay*] balance sheet normalization until [interest rate*] normalization is well under way. Could you give us some sense about “what well under way” means, at least in your mind — what kind of hurdles are you setting, what kind of economic conditions would you like to see, is it a matter of the level of the short term federal funds rate as being the main issue? What kind of role do you see the role of the balance sheet playing in the mobilization process over longer term? Is it an active tool or passive tool? Thanks.

And here is Chair Yellen’s response:

Let me start with the second question first. We have emphasized for quite some time that the committee wishes to use variations in the fed funds rate target or short term interest rate target as our key active tool of policy. We think it’s much easier, in using that tool, to communicate the stance of policy. We have much more experience with it, and have a better idea of its impact on the economy. So, while the balance sheet asset purchases are a tool that we could conceivably resort to if we found ourselves in a serious downturn where we were again up against the zero bound, and faced with substantial weakness in the economy, it’s not a tool that we would want to use as a routine tool of policy.

Mr. Fleming didn’t ask a follow-up question, so naturally I had no way of knowing what he thought of Yellen’s answer. I did, however, know just what I myself thought of it, which was, not much.

In fact, I thought so little of it that I wrote Mr. Fleming to say so. As many of you may also have heard the same exchange, I thought to share my remarks to him publicly, so here they are, minus a paragraph that repeated Yellen’s statement:

Dear Mr. Fleming,

Of the questions posed to Janet Yellen at today’s press conference, I thought yours especially worth asking, and thank you for having asked it. However, I also thought Yellen’s answer unsatisfactory and misleading.

Before the crisis and LSAPs, the Fed didn’t use rate changes instead of balance sheet changes for monetary control. It relied on balance sheet changes, a.k.a. open-market operations, to achieve whatever fed funds rate target it set. In other words, it had decades, dating back to the 1930s, of experience using balance sheet asset purchases (or sales) as, not only “a” policy tool, but as its principal policy tool! Rate change announcements, on the other hand, though they did indeed serve to “communicate the [Fed’s planned] stance” to the public, were incapable by themselves of implementing that stance.

In suggesting that balance sheet changes are an option the Fed might “conceivably resort to…were we again up against the zero bound,”  Yellen seems to equate balance sheet changes in general with “quantitative easing,” where the last refers to the special case, never resorted to until 2008, in which the Fed no longer treats asset purchases as a means to achieve some (positive) fed funds rate target. That confusion, if I’m correct in seeing it as such, represents a pretty elementary error on Yellen’s part. Once again, balance sheet changes were the normal means for the Fed to implement policy before 2008, though they were changes aimed at hitting an announced single-value (and market determined) effective fed funds rate.

Today, with IOER and ON-RRP between them defining the Fed’s ffr target “range” — a “target” it can’t possibly miss — the Fed’s administered rate hike changes ARE the policy changes, since no balance sheet adjustments are required to make them happen. But this approach has only been in effect since the crisis, and has only been employed 3 times so far. So for Yellen to pretend that it’s one that the Fed has “more experience with” is really rather disingenuous.

Once again, thank you for asking the question.



The public needs to see the Fed’s arguments for maintaining its present, boated balance sheet for what they are: mere excuses. It also needs to see the delay for what IT really is:  mere stalling while the Fed and its apologists rally support, in Congress and beyond, for a permanently enlarged Fed footprint on the U.S. credit system.

(For more on the balance sheet question, see here, here, and here.)


*The words in brackets were partly inaudible, so I reproduce them according to my own understanding. Yellen’s statement itself leaves little room for doubt concerning what Mr. Fleming meant to ask.


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