John Williams, president of the Federal Reserve Bank of New York, on Tuesday defended the U.S. central bank’s framework for implementing monetary policy, saying a system of ample reserves had proved effective in steering short-term interest rates and supporting financial-market stability, while acknowledging that it could be adapted to market developments.
In opening remarks prepared for a conference on the Treasury market held at the Federal Reserve Bank of New York, Williams said that using existing tools to manage short-term interest rates, alongside maintaining ample levels of reserves, had proved highly effective in implementing monetary policy.
An adaptable framework
Williams said the success of the current framework did not mean it was fixed or unchangeable, pointing to the need to develop monetary-policy tools in line with shifts in the structure of financial markets and ensure they remained suited to the functions required of them efficiently.
Williams did not address the future outlook for monetary policy or interest rates, and he was not scheduled to take questions after his remarks.
Review of balance-sheet management
Williams’ remarks come as the Federal Reserve examines issues related to monetary-policy implementation, including communications, data assessment and management of its still-large balance sheet. Multiple teams are reviewing these matters under the new leadership of Kevin Warsh.
Warsh had repeatedly criticized the size of the Federal Reserve’s asset holdings and its system of maintaining high levels of reserves before taking over as central-bank chair in May.
The shift from scarce liquidity to ample reserves
Before the 2008 financial crisis, the Federal Reserve followed an approach aimed at limiting liquidity in the financial system, later abandoning that framework. Central-bank officials believe that maintaining strong levels of liquidity and reserves supports financial stability and enhances the ability to control short-term interest rates.
Williams said holding reserves at the central bank should not impose an opportunity cost, or that the cost should be very limited, warning that a high cost could create distortions that undermine market efficiency and stability.
He added that the Federal Reserve would remain responsive to market conditions, explaining that it would adjust the supply of reserves over time if underlying demand for them changed as a result of regulatory adjustments, shifts in market structure or other factors.
