Federal Reserve Board Chair Janet Yellen delivered a speech Friday at the San Francisco Fed entitled, "Normalizing Monetary Policy: Prospects and Perspectives," where she confirmed market expectations "that conditions may warrant an increase in the federal funds rate target sometime this year." Her colleague, Fed Vice Chair Stanley Fischer, also spoke late last week in Germany on, among other things, the role of money market funds in the financial crisis. We review and excerpt these new comments below, and we also report on a new study by global insurer Swiss Re, which says monetary policy since the financial crisis has cost investors almost half a trillion dollars in interest income.

In her speech, Yellen discussed "why most of my colleagues and I believe the return of the federal funds rate to a more normal level is likely to be gradual," and she addressed the question, "[W]hy does the Committee judge that an increase in the federal funds rate target is likely to become appropriate later this year?" She commented, "Like most of my FOMC colleagues, I believe that the appropriate time has not yet arrived, but I expect that conditions may warrant an increase in the federal funds rate target sometime this year."

Yellen added, "The FOMC will, of course, carefully deliberate about when to begin the process of removing policy accommodation. But the significance of this decision should not be overemphasized, because what matters for financial conditions and the broader economy is the entire expected path of short-term interest rates and not the precise timing of the first rate increase.... More important than the timing of the Committee's initial policy move will be the strategy the Committee deploys in adjusting the federal funds rate over time, in response to economic developments, to achieve its dual mandate."

She concluded, "Let me first be clear that the FOMC does not intend to embark on any predetermined course of tightening following an initial decision to raise the funds rate target range -- one that, for example, would involve similarly sized rate increases at every meeting or on some other schedule. Rather, the actual path of policy will evolve as economic conditions evolve, and policy tightening could speed up, slow down, pause, or even reverse course depending on actual and expected developments in real activity and inflation. Reflecting such data dependence, as well as some historically unusual policy considerations that I will discuss shortly, the average pace of tightening observed during previous recoveries could well provide a highly misleading guide to the actual course of monetary policy over the next few years."

In other Fed news, Vice Chair Stanley Fischer spoke on, "The Importance of the Nonbank Financial Sector." (Last week, Fischer also gave a speech discussing the Fed's Reverse Repo Program -- see our March 25 "Link of the Day", "SEC's White Comments on Money Fund Reforms; Fed's Fischer on RRP.") Fischer latest speech said, "The nonbank financial system includes a diverse group of entities such as insurance companies, finance companies, government-sponsored enterprises, hedge funds, security brokers and dealers, issuers of asset-backed securities, mutual funds, and money market funds.... [B]ecause many nonbanks are connected to banks, a shock to the nonbank sector could in turn threaten the stability of the overall banking system--as happened in the unfolding of the Global Financial Crisis."

On the financial crisis, he said, "Some of the first cracks in the nonbank sector appeared in April 2007, when New Century Financial Corporation, at one point the second-biggest subprime mortgage lender, filed for bankruptcy.... A few months later, with subprime assets falling in value, money market investors refused to roll over the asset-backed commercial paper that had been funding many of these subprime assets. With this market shrinking dramatically, the banking sector was left on the hook to support entities that banks had sponsored or to which they had provided some form of credit or liquidity support.... By the dramatic month of September 2008, the chain of interconnections had helped spread the financial pain, and a broader range of firms were caught in the financial maelstrom."

Fischer continued, "Fannie Mae and Freddie Mac entered conservatorship. Lehman Brothers failed when its creditors ran from it as they had from Bear Stearns. American International Group, or AIG, had to be bailed out primarily because of its inability to post enough collateral to cover liabilities on credit protection it had sold on many entities (including Lehman) and because it lost funding in the securities lending market. The Reserve Primary fund, a money market mutual fund, "broke the buck" as a result of its holdings of Lehman securities. Banks were not immune to the financial market stress of this period, but they were far less involved in the unfolding of the crisis than were nonbanks -- a phenomenon that highlighted the importance of the nonbank sector and the vulnerability of the financial system to its distress. When nonbanks pulled back, other parts of the system suffered. When nonbanks failed, other parts of the system failed."

He added, "A crisis as deep as the Global Financial Crisis was bound to produce widespread regulatory changes.... A second nonbank reform has been the Securities and Exchange Commission's (SEC) adoption of new rules for money market mutual funds. Specifically, the SEC will require prime money market funds sold to institutional investors to publish a floating net asset value and to restrict withdrawals through a system of gates and fees. These rules, while as yet untested, are designed to reduce the likelihood of runs on prime money market funds."

Finally, a study by Swiss Re entitled, "Financial Repression: The Unintended Consequences," says that while the Fed's actions were beneficial to managing the financial crisis, they came with a substantial cost. The press release of the 34-page study says, "Seven years after the financial crisis, central banks are still keeping interest rates at historically low levels. Low interest rates help finance governments' debt and lower funding costs, as well as support growth. But such policy actions cause financial repression. This comes at a substantial cost.... [T]he impact of financial repression on markets is undisputable.... `[T]he impact of foregone interest income for households and long-term investors has become substantial: in the US alone, savers have lost about USD 470 billion in interest rate income (net) since the financial crisis (2008-2013)."

The study's "Foreward," written by Group CIO Guido Furer, says, "Central banks have done an extraordinarily good job of stabilising financial markets, restoring economic confidence and fighting the threat of deflation -- no question about that. But seven years after the financial crisis, interest rates are still being kept at historically low levels, mainly due to the ongoing low growth environment. Do low interest rates really help to overcome the global economic malaise? Doubts abound. They certainly do have one effect: That is, helping governments to direct funds to themselves to finance their debt and lower their funding costs -- a set of policies known as financial repression. Indeed, policymakers' actions to manage the financial crisis resulted in significant benefits for society at large. But today, the advantages of those ongoing actions are outweighed by their costs. As well as resulting in lower interest earnings on savings, financial repression serves as a disincentive for policymakers to tackle pressing public policy challenges."

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