Monetary Policy in the United States: The Risks Associated With Unconventional Policies

The Federal Reserve has pursued a number of unconventional policies since the financial crisis of 2007–2008. It lowered the short-term interest rate to near zero in 2008, where it remains today. In addition, it has attempted to influence longer-term interest rates through two channels: “forward guidance” announcements stating that monetary policy will remain accommodative until labor market conditions improve and large-scale long-term asset purchases, including mortgage-backed securities, or MBS. The Fed will face risks as it pursues its “exit strategy” from recent unconventional policies. The combination of a very large balance sheet and forward guidance raises the potential of a timing error when it becomes appropriate to raise rates, as well as the consequences of such an error. In addition, by purchasing MBS, the Fed has targeted a specific private sector asset and engaged in credit policy. Such actions could invite pleading from other sectors and entangle the Fed in distributional politics and threaten its independence.