Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 173

Unconventional monetary policy is now conventional

The speech delivered by Janet Yellen, Chair of the Federal Reserve, on 26 August 2016 at the Jackson Hole symposium titled The Federal Reserve’s Monetary Policy Toolkit: Past, Present, and Future offered a unique insight into how the Fed (and by implication how other global central banks) will conduct monetary policy in the years ahead.

‘Equilibrium’ cash rate lowest in 50 years

There is a need to build policy resiliency and flexibility, which is especially important with the equilibrium or normal real cash rate materially lower than it has been over the 40 years leading up to the GFC. In practical terms, the normal real cash rate is where inflation is seen to be stable and output on average is close to potential. It is entirely plausible the normal real cash rate is now close to zero, compared to around 2.5% in the past. Significantly, the result is that the scope to raise nominal interest rates to levels that prevailed in past cycles will be very limited and unnecessary given the future prospects for growth and inflation.

The subdued medium-term growth and inflation outlook reflects weaker employment and productivity outcomes inhibiting consumption, a lack of attractive projects for capital investment, and demographic factors such as declining population growth. In some countries such as Japan and across Europe, the issue is more acute and this is where official cash rates have been moved into negative territory. There is strong evidence that negative rates have arrested a steeper decline in output and growth than otherwise – especially in the absence of the political and economic power to expand fiscal policy when sovereign debt burdens were so high.

Janet Yellen has messaged several important thematics shaping the Fed‘s thinking, including the future monetary policy framework which will include an expanded monetary policy toolkit. There is no going back to the conventional and simple adjustments to the policy cash rate. The so-called unconventional monetary policy measures will remain in scope for years to come. This means central banks will have much larger balance sheets, they will continue to use forward guidance, make targeted asset purchases and, as required, change the level of interest rate paid on excess reserves banks hold with the central bank.

Negative rates counterproductive

By its omission, it may be concluded that the US toolkit does not contemplate negative official cash rates. There is mounting evidence that negative rates adversely impact bank profitability which could ultimately weaken the stability of the financial system and at its extreme becomes a tax on savers. In parts of Europe, depositors are paying banks to leave their money on deposit, with a potential adverse impact on investor and consumer confidence. It can encourage distortions in other asset prices as investors hunt for yield.

We are also seeing a divergence in approach across central banks in the tools employed. This reflects a few factors – including weaker inflation and economic performance and the way the credit channel operates in different economies. For example, the European Central Bank, having moved to negative rates and purchased significant proportions of the European sovereign debt market, are now buying corporate debt. This reduces the cost of corporate borrowing by driving yields lower. Yellen’s speech alluded to this approach: the ability if required to expand the types of assets purchased to be added to the toolkit. The Bank of Japan seems set to continue its expansion of balance sheets and further moves into negative rates, although clearly mindful of unintended consequences.

Even if rates rise, the peak will be very low

So where does this end? Not any time soon because there is no real alternative. Rates are set to remain very low for a long time with punctuations of volatility but not a sustained rise. We continue to look for a handoff to fiscal policy and even a recognition that some bank regulation is a disincentive to capital investment and inhibits the free flow of capital. For the Fed, a further policy tightening is likely before end 2016. Yellen refers to the asymmetry of risks and that there is no pre-set path. This is why the Fed’s approach will be gradual and data dependent. The nominal Fed funds rate peak in this cycle may be as low as 2%.

 

Anne Anderson is Head of Fixed Income at UBS Australia. This article is general information and does not consider any investor’s circumstances.

 

  •   15 September 2016
  •      
  •   

 

Leave a Comment:

RELATED ARTICLES

Shares rebound on hopes of war ending, but stalemate the likely outcome

Five simple reasons why Australian cash rates are highest

Trusting the process in a high-rate environment

banner

Most viewed in recent weeks

Little‑known government scheme can help retirees tap into $3 trillion of housing wealth

The Home Equity Access Scheme in Australia allows older homeowners to tap into their home equity for retirement income, yet remains underused due to lack of awareness and its perceived complexity.

Origins of the mislabeled capital gains tax ‘discount’

Debate over the CGT discount is intensifying amid concerns about intergenerational equity and housing affordability. This analysis shows that the 'discount' does not necessarily favor property investors.

2 billion reasons to fix retirement income

A proposal to address Australia's 'stranded balances' in retirement by requiring super funds to transition members to pension phase at 65, boosting retirement income and reframing super as a source of income.

The ultimate superannuation EOFY checklist 2026

Here is a checklist of 28 important issues you should address before June 30 to ensure your SMSF or other super fund is in order and that you are making the most of the strategies available.

Div 296 may mean your estate pays tax on assets your beneficiaries never receive

The new super tax, applying from 1 July, introduces more than just a higher rate on large balances. It brings into focus a misalignment between where wealth sits and where the tax on that wealth ultimately falls.

Do super funds need a massive wake up call?

UK retirement expert, Guy Opperman, believes super funds are failing at supporting members in deaccumulation. Here is what Australia should do about it. 

Latest Updates

Retirement

How inflation is quietly moving the goalposts on retirement

Inflation doesn’t just raise today’s bills - it quietly increases the amount needed to retire, while simultaneously making it harder to save. Three steps to take before June 30th to improve retirement outcomes.

Investment strategies

Three strategies for investing amid AI whiplash

AI fears have shifted from bubble talk to disruption anxiety, driving investors toward asset-heavy, 'AI-resistant' businesses while punishing many software and service firms. This environment may be ripe for stock pickers.

Investment strategies

Are private market assets the answer in an unstable world?

Private markets can offer diversification and return potential, but their opacity, scale and wide dispersion of outcomes make manager selection and due diligence critical for non‑institutional investors.

Property

Mispriced in plain sight: The case for Global REITs

Global REITs have fallen out of favour, trading at deep discounts after years of underperformance, despite resilient earnings and improving fundamentals.

Investment strategies

Survival is the only success

True financial success isn’t about how much you make, but whether you can sustain it — survival is the only win that matters.

Investment strategies

$42 billion too late

Why Australia's biggest energy bet may already be redundant while a less celebrated government program is exceeding expectations. 

Investment strategies

Do investors accept lower returns from assets that make them feel good?

Assets that deliver emotional satisfaction tend to offer lower financial returns, as investors accept an “emotional yield” in place of performance which shapes how investors approach ESG and unpopular assets.

Sponsors

Alliances

© 2026 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. To the extent any content is general advice, it has been prepared for clients of Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), without reference to your financial objectives, situation or needs. For more information refer to our Financial Services Guide. You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.