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

Testamentary trusts post-budget: Estate planning, tax reform and the ‘death tax’ debate

Proposed Budget changes to taxation are casting new uncertainty over testamentary trusts, prompting closer scrutiny of estate planning structures and the real implications of reforms still taking shape.

High quality businesses are on sale

Beneath the dominance of the ASX's largest stocks, much of the market has been left behind. High-quality companies are now trading at levels rarely seen, offering opportunities for investors willing to look deeper.

Meg on SMSFs: The CGT changes don’t impact super but what about Div 296 tax decisions?

New CGT rules could tip the scales in the super vs non-super debate. For those facing the Division 296 tax, the case for withdrawing has gotten more complex. A "comparison rate" tool may help assess decisions.

The strange effect of the 30% minimum capital gains tax

The 30% minimum tax on capital gains sits at the heart of the budget's proposed reforms. Yet the mechanics reveal anomalies that introduce unexpected distortions that raise questions about its design.

Ranking three common retirement strategies

The defining challenge of retirement isn't just about building wealth, it's about converting your lifetime savings into sustainable income. A holistic understanding of different strategies can improve long-term outcomes.

Welcome to Firstlinks Edition 667 with weekend update

The downfall of the giant and three lessons for investors.

  • 18 June 2026

Latest Updates

Planning

Does your will qualify for the discretionary testamentary trust exemption?

Treasury has confirmed the exemption many families were hoping for. But buried in the fine print are two conditions that could leave some wills on the wrong side of the exemption, despite years of careful planning.

Lithium's latest drop and what it means for ASX investors

Lithium's latest sell-off has punished ASX miners as prices remain hostage to shifting expectations. The key challenge is navigating a market prone to extreme volatility despite a strong case for the long-term demand outlook.

Investment strategies

CGT reform and fund turnover: who really feels the impact?

The implications of CGT reform are far and wide. As the 50% discount gives way to inflation indexation, turnover and return profiles may become critical drivers of after-tax performance. Some strategies face a far greater hit.

Superannuation

Super was built for a very different Australia

Our retirement system was built around assumptions that no longer hold. Lower homeownership, longer lifespans and changing expectations are exposing cracks that policymakers and super funds need to address.

Retirement

Retirement in reality - 4 months in

Many people spend years planning financially for retirement but little time preparing for what comes next. Four months in, here are the surprising lessons I've learnt on finding purpose, social connection and healthy habits.

Investment strategies

After the Budget, Australia needs its own definition of quality

As tax reforms reshape investment incentives, investors should rethink what quality investing means in the uniquely concentrated Australian market, where traditional frameworks may not translate as effectively.

Datacenters are the new shale oil

Why are tech giants pouring billions into datacentres when the economics look questionable? The most dangerous words in investing may be: "everyone else is doing it". Today's AI boom has striking parallels with the shale bust.

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.