Monetary Policy and the Federal Reserve: Current Policy and Conditions

Summary

The Federal Reserve (the Fed) defines monetary policy as its actions to influence the availability and cost of money and credit. Because the expectations of market participants play an important role in determining prices and economic growth, monetary policy can also be defined to include the directives, policies, statements, and actions of the Fed that influence future perceptions. Congress has delegated responsibility for monetary policy to the Fed but retains oversight responsibilities for ensuring that the Fed is adhering to its statutory mandate of "maximum employment, stable prices, and moderate long-term interest rates." To meet its price stability mandate, the Fed has set a longer-run goal of 2% inflation.

While the federal funds target was at the zero lower bound, the Fed attempted to provide additional stimulus through unsterilized purchases of Treasury and mortgage-backed securities (MBS), a practice popularly referred to as quantitative easing (QE). Between 2009 and 2014, the Fed undertook three rounds of QE. The third round was completed in October 2014, at which point the Fed's balance sheet was $4.5 trillion—five times its pre-crisis size. Although QE has ended, the Fed has announced that it intends to maintain the balance sheet at its current level for the time being. In September 2014, the Fed announced a framework for normalizing monetary policy after QE, explaining that it will raise interest rates in the presence of a large balance sheet mainly by raising the rate of interest paid to banks on reserves and by engaging in reverse repurchase agreements (reverse repos).

For an overview of legislation, see CRS Report R44273, Federal Reserve: Legislation in the 114th Congress, by [author name scrubbed].

Introduction

Congress has delegated responsibility for monetary policy to the Federal Reserve (the Fed), but retains oversight responsibilities to ensure that the Fed is adhering to its statutory mandate of "maximum employment, stable prices, and moderate long-term interest rates."¹ The Fed has defined stable prices as a longer-run goal of 2% inflation (as measured by the Personal Consumption Expenditures price index).² The Fed's responsibilities as the nation's central bank fall into four main categories: monetary policy, provision of emergency liquidity through the lender of last resort function, supervision of certain types of banks and other financial firms for safety and soundness, and provision of payment system services to financial firms and the government.³

Although monetary policy is now less stimulative than it had been at the zero lower bound, the Fed is still adding stimulus to the economy as long as rates are below what economists call the "neutral rate" (or the long-run equilibrium rate).⁵ The Fed's forward guidance on its expectations for future rates is that the Fed intends to keep stimulative policy in place for some time—it currently "expects that economic conditions will evolve in a manner that will warrant only gradual increases in the federal funds rate; the federal funds rate is likely to remain, for some time, below levels that are expected to prevail in the longer run."⁶

As the economic recovery consistently proved weaker than expected, the Fed repeatedly pushed back the timeframe for raising interest rates. As a result, the economic expansion was in its seventh year and the unemployment rate was already near the Fed's estimate of full employment when it began raising rates. This was a departure from past practice—by contrast, in the previous two economic expansions, the Fed began raising rates within three years of the preceding recession ending.

The Fed's unprecedented policy stance has been controversial. Because the recent recession was unusually severe, economists disagree about both how much slack remains in the economy today and how quickly the Fed should remove monetary stimulus. The unemployment rate is projected to be slightly below the Fed's estimate of full employment in 2016, but other labor market measures indicate that an employment gap remains. The Fed has indicated that the economy is currently on a path to achieve maximum employment, and inflation will return to 2% in the medium term.

Economists who argue that the Fed should not raise rates too quickly contend that a large output gap (i.e., the difference between actual output and potential output) still exists and note that the Fed's preferred measure of inflation has been slightly below its 2% goal since 2013 (or 2012 if food and energy prices are omitted). They point to the experiences of the Eurozone recently and of Japan since the 1990s as illustrating the risks that removing monetary stimulus too soon after a financial crisis could lead to deflation (falling prices) and prematurely choke off the expansion.⁷ In other words, they contend leaving monetary stimulus in place can be justified until both the Fed's full employment mandate and its price stability mandate are met.

Economists who currently argue that low rates have been in place too long contend that the recovery is sustainable without monetary stimulus. They point out that the economic recession ended in June 2009 and that the economy has been growing steadily since. Although inflation has remained low thus far, normally, pursuing a stimulative monetary policy when the economy has reached full employment would be expected to lead to rising inflation. Further, they contend that unconventional policy has led to above-average growth in the money supply that arguably poses a threat to price stability.⁸ They are also concerned that the Fed's large balance sheet and prolonged use of monetary stimulus threatens financial stability through potential asset bubbles or market distortions. In critics' eyes, the economy is now functioning close enough to normal that the risks of continuing a highly stimulative policy outweigh the benefits.⁹

As December 2015 marked the first time that the Fed raised rates since 2008, it also marked the first time in recent years that U.S. short-term interest rates were rising relative to other countries. Economy theory predicts that this relative difference in rates will attract capital flows into the United States, thereby pushing up the exchange rate value of the dollar. In fact, the value of the dollar has been rising since mid-2014. A stronger dollar reduces aggregate demand (total spending) by reducing demand for exports and import-competing goods, all else equal.

Another legacy of the financial crisis is the Fed's large balance sheet. Because the Fed could not provide any further stimulus through conventional policy at the zero lower bound, it turned to unconventional policy to provide further stimulus to the economy.¹⁰ The Fed attempted to stimulate the economy through three rounds of large-scale asset purchases of U.S. Treasury securities, agency debt, and agency mortgage-backed securities (MBS) beginning in 2009, popularly referred to as quantitative easing (QE).¹¹ The third round was completed in October 2014, at which point the Fed's balance sheet was $4.5 trillion—five times its pre-crisis size. The end of QE was the first step to normalize monetary policy. Instead of normalizing monetary policy by selling its assets to reduce its balance sheet, the Fed has raised rates while maintaining the balance sheet at its current size for the time being. This has been made possible through increases in the interest rate the Fed pays banks on the reserves deposited at the Fed and reverse repurchase agreements (reverse repos).¹² Some critics have expressed concerns regarding how the Fed's normalization policy might affect inflation, asset prices, and the functioning of certain financial markets, such as the repo market.

The Fed defines monetary policy as the actions it undertakes to influence the availability and cost of money and credit to promote the goals mandated by Congress, a stable price level and maximum sustainable employment. Because the expectations of households as consumers and businesses as purchasers of capital goods exert an important influence on the major portion of spending in the United States, and because these expectations are influenced in important ways by the Fed's actions, a broader definition of monetary policy would include the directives, policies, statements, economic forecasts, and other Fed actions, especially those made by or associated with the chairman of its Board of Governors, who is the nation's central banker.

The Federal Reserve has traditionally relied on three instruments to conduct monetary policy:

What Are Repos?

The bursting of the housing bubble led to the onset of a financial crisis that affected both depository institutions and other segments of the financial sector involved with housing finance. As the delinquency rates on home mortgages rose to record numbers, financial firms exposed to the mortgage market suffered capital losses and lost access to liquidity. The contagious nature of this development was soon obvious as other types of loans and credit became adversely affected. This, in turn, spilled over into the broader economy, as the lack of credit soon had a negative effect on both production and aggregate demand. In December 2007, the economy entered a recession.

As the housing slump's spillover effects to the financial system, as well as its international scope, became apparent, the Fed responded by reducing the federal funds target and the discount rate.³³ Beginning on September 18, 2007, and ending on December 16, 2008, the federal funds target was reduced from 5.25% to a range between 0% and 0.25%, where it currently remains. Economists call this the zero lower bound to signify that once the federal funds rate is lowered to zero, conventional open market operations cannot be used to provide further stimulus.

The decision to maintain a target interest rate near zero is unprecedented. First, short-term interest rates have never before been reduced to zero in the history of the Federal Reserve.³⁴ Second, the Fed has waited much longer than usual to begin tightening monetary policy in this recovery. For example, in the previous two expansions, the Fed began raising rates less than three years after the preceding recession ended.

With liquidity problems persisting as the federal funds rate was reduced, it appeared that the traditional transmission mechanism linking monetary policy to activity in the broader economy was not working. Monetary authorities became concerned that the liquidity provided to the banking system was not reaching other parts of the financial system. Using only traditional monetary policy tools, additional monetary stimulus cannot be provided once the federal funds rate has reached its zero bound. To circumvent this problem, the Fed decided to use nontraditional methods to provide additional monetary policy stimulus.

First, the Federal Reserve introduced a number of emergency credit facilities to provide increased liquidity directly to financial firms and markets. The first facility was introduced in December 2007, and several were added after the worsening of the crisis in September 2008. These facilities were designed to fill perceived gaps between open market operations and the discount window, and most of them were designed to provide short-term loans backed by collateral that exceeded the value of the loan.³⁵ A number of the recipients were nonbanks that are outside the regulatory umbrella of the Federal Reserve; this marked the first time that the Fed had lent to nonbanks since the Great Depression. The Fed began to employ a seldom-used emergency provision, Section 13(3) of the Federal Reserve Act,³⁶ that allows it to make loans to other financial institutions and to nonfinancial firms as well.

The Fed provided assistance through liquidity facilities, which included both the traditional discount window and the newly created emergency facilities mentioned above, and through direct support to prevent the failure of two specific institutions, American International Group (AIG) and Bear Stearns. The amount of assistance provided was an order of magnitude larger than normal Fed lending. Total assistance from the Federal Reserve at the beginning of August 2007 was approximately $234 million provided through liquidity facilities, with no direct support given. In mid-December 2008, this number reached a high of $1.6 trillion, with a near-high of $108 billion given in direct support. From that point on, it fell steadily. Assistance provided through liquidity facilities fell below $100 billion in February 2010, when many facilities were allowed to expire, and support to specific institutions fell below $100 billion in January 2011.³⁷ The last loan from the crisis was repaid on October 29, 2014.³⁸ Central bank liquidity swaps (temporary currency exchanges between the Fed and central foreign banks) are the only facility created during the crisis that is still active, but they have not been used on a large scale since 2012. All assistance through expired facilities has been fully repaid with interest. In 2010, the Dodd-Frank Act³⁹ changed Section 13(3) to rule out direct support to specific institutions in the future.

From the introduction of its first emergency lending facility in December 2007 to the worsening of the crisis in September 2008, the Fed sterilized the effects of lending on its balance sheet by selling an offsetting amount of Treasury securities. After September 2008, assistance exceeded remaining Treasury holdings, and the Fed allowed its balance sheet to grow. Between September 2008 and November 2008, the Fed's balance sheet more than doubled in size, increasing from less than $1 trillion to more than $2 trillion. The loans and other assistance provided by the Federal Reserve to banks and nonbank institutions are considered assets on this balance sheet because they represent money owed to the Fed.

With the federal funds rate at its zero bound since December 2008 and direct lending falling as financial conditions began to normalize in 2009, the Fed faced the decision of whether to try to provide additional monetary stimulus through unconventional measures. It did so through two unconventional tools—large-scale asset purchases (quantitative easing) and forward guidance.

(billions of dollars)

Treasury Security Holdings

Agency MBS Holdings

Agency Debt Holdings

Total Assets

+$302

+$1,129

+$168

+$451

+$788

-$142

-$35

+$578

+$810

+874

-$48

+$1,663

+$1,987

+$1,718

+$40

+$2,587

This increase in the Fed's assets must be matched by a corresponding increase in the liabilities on its balance sheet. The Fed's liabilities mostly take the form of currency, bank reserves, and cash deposited by the U.S. Treasury at the Fed. QE has mainly resulted in an increase in bank reserves, from about $46 billion in August 2008 to $820 billion at the end of 2008. Since October 2009, bank reserves have exceeded $1 trillion, and they have been between $2.5 trillion and $2.8 trillion since 2014.⁴¹ The increase in bank reserves can be seen as the inevitable outcome of the increase in assets held by the Fed because the bank reserves, in effect, financed the Fed's asset purchases and loan programs. Reserves increase because when the Fed makes loans or purchases assets, it credits the proceeds to the recipients' reserve accounts at the Fed.

The intended purpose of QE was to put downward pressure on long-term interest rates. Purchasing long-term Treasury securities and MBS should directly reduce the rates on those securities, all else equal. The hope is that a reduction in those rates feeds through to private borrowing rates throughout the economy, stimulating spending on interest-sensitive consumer durables, housing, and business investment in plant and equipment. Indeed, Treasury and mortgage rates have been unusually low since the crisis compared with the past few decades, although the timing of declines in those rates do not match up closely to the timing of asset purchases. Determining whether QE has reduced rates more broadly and stimulated interest-sensitive spending requires controlling for other factors, such as the weak economy, which tends to reduce both rates and interest-sensitive spending.⁴²

The increase in the Fed's balance sheet has the potential to be inflationary because bank reserves are a component of the portion of the money supply controlled by the Fed (called the monetary base), which has grown at an unprecedented pace during QE. In practice, overall measures of the money supply have not grown as quickly as the monetary base, and inflation has remained below the Fed's goal of 2% for most of the time since 2008. The growth in the monetary base has not translated into higher inflation because bank reserves have mostly remained deposited at the Fed and have not led to increased lending or asset purchases by banks.

Another concern is that by holding large amounts of MBS, the Fed is allocating credit to the housing sector, putting the rest of the economy at a disadvantage compared with that sector. Advocates of MBS purchases note that housing was the sector of the economy most in need of stabilization, given the nature of the crisis (this argument becomes less persuasive as the housing market continues to rebound); that MBS markets are more liquid than most alternatives, limiting the potential for the Fed's purchases to be disruptive; and that the Fed is legally permitted to purchase few other assets, besides Treasury securities.

Another tool the Fed has used recently to achieve additional monetary stimulus at the zero bound is a pledge to keep the federal funds rate low for an extended period of time, which has been called forward guidance or forward commitment. The Fed believes this will stimulate economic activity because businesses, for example, will be more likely to take on long-term investment commitments if they are confident rates will be low over the life of a loan. Over time, this forward guidance became more detailed and explicit. In August 2011, the Fed set a date for how long it expected to maintain "exceptionally low levels for the federal funds rate." In December 2012, the Fed replaced the date threshold with an economic threshold: it pledged to maintain an "exceptionally low" federal funds target at least as long as unemployment is above 6.5% and inflation is low.

It is difficult to pinpoint how effective the forward guidance tool has been, in part because its efficacy depends on how credible market participants find the commitment. Because economic conditions may unexpectedly change, this commitment is only a contingent one, causing the Fed's commitment to change when conditions change. This occurred in 2013-2014, when the unemployment rate fell unexpectedly rapidly without a commensurate improvement in broader labor market or economic conditions.⁴³ Had the Fed followed its existing forward guidance, the fall in the unemployment rate would have led to a tightening of policy sooner than intended. Instead, as the unemployment rate neared 6.5% in March 2014, the Fed replaced the specific unemployment threshold in its forward guidance with a vaguer statement—"The Committee currently anticipates that, even after employment and inflation are near mandate-consistent levels, economic conditions may, for some time, warrant keeping the target federal funds rate below levels the Committee views as normal in the longer run."⁴⁴ Less specific statements provide less clarity to market participants about the path of future rates, but future policy is less likely to need to deviate from them.

The Fed's forward guidance has signaled a more aggressively stimulative policy stance than the Fed has taken in the past. Typically, the Fed keeps interest rates below normal when the economy is operating below full employment, at normal levels when the economy is near full employment, and above normal when the economy is overheating. Because of lags between changes in interest rates and their economic effects, the Fed often will preemptively change its monetary policy stance before the economy reaches the state that the Fed is anticipating. By contrast, in this case, the Fed has pledged to keep interest rates below normal even after the economy is approaching full employment. Normally, such a stance would risk resulting in high inflation. In this case, the Fed views low inflation as a greater risk than high inflation.

On October 29, 2014, the Fed announced that it would stop making large-scale asset purchases at the end of the month.⁴⁵ Now that QE is completed, attention has turned to the Fed's "exit strategy" from QE and zero interest rates. The Fed laid out its plans to normalize monetary policy in a statement in September 2014.⁴⁶ It plans to continue implementing monetary policy by targeting the federal funds rate.⁴⁷ The basic challenge to doing so is that the Fed cannot effectively alter the federal funds rate by altering reserve levels (as it did before the crisis) because QE has flooded the market with excess bank reserves. In other words, in the presence of more than $2 trillion in bank reserves, the market-clearing federal funds rate is close to zero.⁴⁸

The most straightforward way to return to normal monetary policy would be to remove those excess reserves by shrinking the balance sheet through asset sales. In its normalization statement, the Fed ruled out MBS sales and indicated that it does not intend to sell Treasury securities in the near term. Instead, it eventually plans gradual reductions in the balance sheet by ceasing to roll over securities as they mature. However, the Fed continued rolling over maturing securities after it began raising the federal funds rate. The Fed intends to ultimately reduce the balance sheet until it holds "no more securities than necessary to implement monetary policy efficiently," which Fed Chair Janet Yellen stated might not occur until the end of the decade.⁴⁹ At that point, it plans to hold primarily Treasury securities.

(billions of dollars; percentages)

2009

2010

2011

2012

2013

2014

Treasury Securities

Net Purchases by Fed

$300.8

$244.9

$642.0

$2.7

$542.6

$252.6

Net Issuance

$1,443.7

$1,579.6

$1,066.8

$1,140.6

$759.5

$670.5

Net Purchases/Net Issuance

20.8%

15.5%

60.2%

0.2%

71.4%

37.7%

Agency MBS

Net Purchases by Fed

$908.4

$83.8

-$154.5

$89.0

$563.5

$248.2

Net Issuance

$506.8

-$107.3

$16.0

$71.9

$152.3

$90.1

Net Purchases/Net Issuance

179.2%

NA

NA

123.8%

370.0%

275.5%

The Fed has distinct roles as a central bank and a regulator. Its main regulatory responsibilities are as follows:

• Bank regulation. The Fed supervises bank holding companies (BHCs) and thrift holding companies (THCs), which include all large and thousands of small depositories, for safety and soundness.⁵⁷ The Dodd-Frank Act requires the Fed to subject BHCs with more than $50 billion in consolidated assets to enhanced prudential regulation (i.e., stricter standards than are applied to similar firms) in an effort to mitigate the systemic risk they pose.⁵⁸ The Fed is also the prudential regulator of U.S. branches of foreign banks and state banks that have elected to become members of the Federal Reserve System. Often in concert with the other banking regulators,⁵⁹ it promulgates rules and supervisory guidelines that apply to banks in areas such as capital adequacy, and examines depository firms under its supervision to ensure that those rules are being followed and those firms are conducting business prudently. The Fed's supervisory authority includes consumer protection for banks under its jurisdiction that have $10 billion or less in assets.⁶⁰
• Prudential regulation of nonbank systemically important financial institutions. The Dodd-Frank Act allows the Financial Stability Oversight Council (FSOC)⁶¹ to designate nonbank financial firms as systemically important (SIFIs). Designated firms are supervised by the Fed for safety and soundness.
• Regulation of the payment system. The Fed regulates the retail and wholesale payment system for safety and soundness. It also operates parts of the payment system, such as interbank settlements and check clearing. The Dodd-Frank Act subjects payment, clearing, and settlement systems designated as systemically important by the FSOC to enhanced supervision by the Fed (along with the Securities and Exchange Commission and the Commodity Futures Trading Commission, depending on the type of system).
• Margin requirements. The Fed sets margin requirements on the purchases of certain securities, such as stocks, in certain private transactions. The purpose of margin requirements is to mandate what proportion of the purchase can be made on credit.

The Fed attempts to mitigate systemic risk and prevent financial instability through these regulatory responsibilities, as well as through its lender of last resort activities and participation on the FSOC (whose mandate is to identify risks and respond to emerging threats to financial stability). The Fed has also restructured its internal operations to facilitate a macroprudential approach to supervision and regulation.⁶²

Author Contact Information

Acknowledgments

This report was originally authored by [author name scrubbed], formerly of the Congressional Research Service.

Footnotes

Section 2A of the Federal Reserve Act, 12 U.S.C. 225a.

Federal Reserve, Statement on Longer-Run Goals and Monetary Policy Strategy, January 24, 2012, at http://www.federalreserve.gov/monetarypolicy/files/FOMC_LongerRunGoals.pdf.

For background on the makeup of the Federal Reserve, see CRS In Focus IF10054, Introduction to Financial Services: The Federal Reserve, by [author name scrubbed].

The Federal Open Market Committee's (FOMC's) monetary policy announcements can be accessed at http://www.federalreserve.gov/monetarypolicy/fomccalendars.htm.

There is evidence that the neutral rate fell during the financial crisis and may remain below historical norms. If so, then monetary policy has been less stimulative than if the neutral rate had remained stable.

FOMC, press release, January 27, 2016, at http://www.federalreserve.gov/newsevents/press/monetary/20160127a.htm.

Charles Evans et al. argue that the risks of withdrawing stimulus too soon outweigh the risks of withdrawing too late. See Charles Evans et al., "Risk Management for Monetary Policy Near the Zero Lower Bound," working paper, March 9, 2015, http://www.brookings.edu/about/projects/bpea/papers/2015/risk-management-monetary-policy-zero-lower-bound.

The Fed contends that money supply growth is a less accurate predictor of inflation because of changes to the monetary framework.

See, for example, John Taylor, "A Monetary Policy for the Future," speech at the International Monetary Fund, April 15, 2015, http://web.stanford.edu/~johntayl/2015_pdfs/A_Monetary_Policy_For_the_Future-4-15-15.pdf.

In this context, agency securities and mortgage-backed securities (MBS) are primarily securities issued by Fannie Mae and Freddie Mac, but they also include securities issued by the Federal Home Loan Banks and Ginnie Mae.

For more information about repurchase agreements (repos), see the "How Does the Federal Reserve Execute Monetary Policy?" section below.

For a technical discussion of how this is actually done, see Cheryl L. Edwards, "Open Market Operations in the 1990s," Federal Reserve Bulletin, November 1997, pp. 859-872; Benjamin Friedman and Kenneth Kuttner, "Implementation of Monetary Policy: How Do Central Banks Set Interest Rates?," National Bureau of Economic Research, working paper, no. 16165, March 2011.

See the section below entitled "The "Exit Strategy": Normalization of Monetary Policy After QE."

Checking accounts are subject to reserve requirements, but savings accounts are not. As a result, the Fed defines by regulation the different characteristics that checking and savings accounts may have. For example, savings accounts are subject to a limit on monthly withdrawals.

The deposit threshold is regularly adjusted for inflation. For current reserve requirements, see http://www.federalreserve.gov/monetarypolicy/reservereq.htm.

In the 113^th Congress, H.R. 3240 was passed by the House. It would have required GAO to conduct a study on the impact of reserve requirements on banks, consumers, and monetary policy. Under existing law (31 U.S.C. 714(b)), GAO's authority to audit the Fed does not include authority to audit certain operations, including "reserves of member banks," however.

All depository institutions, as defined by 12 U.S.C. 461, may borrow from the discount window and are subject to reserve requirements regardless of whether they are members of the Federal Reserve.

Until 2003, the discount rate was set slightly below the federal funds target, and the Fed used moral suasion to discourage healthy banks from profiting from this low rate. To reduce the need for moral suasion, lending rules were altered in early 2003. Since that time, the discount rate has been set at a penalty rate above the federal funds rate target. However, during the financial crisis, the Fed encouraged banks to use the discount window.

Of the three monetary policy tools described above, the board is generally responsible for setting reserve requirements and interest rates paid or levied by the Fed, whereas open market operations are set by the FOMC. In practice, the board and FOMC coordinate the use of these tools to implement a consistent monetary policy stance.

Depository institutions are obligated by law to hold some fraction of their deposit liabilities as reserves. They are also likely to hold additional or excess reserves based on certain risk assessments they make about their portfolios and liabilities. Until very recently, these reserves were non-income earning assets. The Fed now pays interest on both types of reserves. It is too early to assess how this shift in policy will affect bank reserve holdings.

See, for example, Anthony M. Santomero, "Great Expectations: The Role of Beliefs in Economics and Monetary Policy," Business Review, Federal Reserve Bank of Philadelphia, Second Quarter 2004, pp. 1-6, and Gordon H. Sellon, Jr., "Expectations and the Monetary Policy Transmission Mechanism," Economic Review, Federal Reserve Bank of Kansas City, Fourth Quarter 2004, pp. 4-42.

Bank for International Settlements, "Monetary Policy in a World with Macro Prudential Policy," speech by Jaime Caruana on June 11, 2011, http://www.bis.org/speeches/sp110610.htm.

Two interesting papers bearing on what monetary policy can accomplish by two former officials of the Federal Reserve are Anthony M. Santomero, "What Monetary Policy Can and Cannot Do," Business Review, Federal Reserve Bank of Philadelphia, First Quarter 2002, pp. 1-4, and Frederic S. Mishkin, "What Should Central Banks Do?," Review, Federal Reserve Bank of St. Louis, November/December 2000, pp. 1-14.

To some extent, fiscal policy automatically mitigates changes in the business cycle without any policy changes because tax revenue falls relative to GDP and certain mandatory spending (such as unemployment insurance) rises when economic growth slows and vice versa.

For more information, see CRS Report RL31056, Economics of Federal Reserve Independence, by [author name scrubbed].

An exception to the rule would be a situation in which the economy is far enough below full employment that virtually no crowding out takes place because the stimulus to spending generates enough resources to finance new capital spending.

For more information, see CRS Report RL31235, The Economics of the Federal Budget Deficit, by [author name scrubbed].

It is important to take this possibility into consideration when evaluating the potential effects of fiscal policy on the business cycle. Because the Fed presumably chooses (and continually updates) a monetary policy that aims to keep the economy at full employment, the Fed would need to alter its policy to offset the effects of any stimulative fiscal policy changes that moved the economy above full employment. Thus, the actual net stimulative effect of a fiscal policy change (after taking into account monetary policy adjustments) could be less than the effects in isolation.

Historical and current targets for the federal funds rate can be found at http://www.federalreserve.gov/fomc/fundsrate.htm.

In a Wall Street Journal opinion article, six economists are polled regarding if the Fed was to blame for creating the housing bubble that in part led to the recent financial crisis, and five of the six responded that the Fed in some degree was to blame. See David Henderson, "Did the Fed Cause the Housing Bubble?," Wall Street Journal, March 27, 2009.

See Ben Bernanke, "The Global Saving Glut and the U.S. Current Account Deficit," speech at the Virginia Association of Economists, March 10, 2005.

For a detailed account of the Fed's role in the financial crisis, see CRS Report RL34427, Financial Turmoil: Federal Reserve Policy Responses, by [author name scrubbed].

The Fed did not target the federal funds rate as its monetary policy instrument until the late 1980s or early 1990s. (See Daniel Thornton, "When Did the FOMC Begin Targeting the Federal Funds Rate?," Federal Reserve Bank of St. Louis, working paper 2004-015B, May 2005, http://research.stlouisfed.org/wp/2004/2004-015.pdf.) Data on the federal funds rate back to 1914 is not available. Before 2008, the Fed had not set its discount rate (the rate charged at the Fed's discount window) as low as 0.5% since 1914.

See CRS Report R44185, Federal Reserve: Emergency Lending, by [author name scrubbed].

12 U.S.C. 343.

Data from "Recent Balance Sheet Trends," Credit and Liquidity Programs and the Balance Sheet, http://www.federalreserve.gov/monetarypolicy/bst_recenttrends.htm. Values include totals from credit extended through Federal Reserve liquidity facilities and support for specific institutions.

Federal Reserve, Quarterly Report on Federal Reserve Balance Sheet Developments, November 2014, http://www.federalreserve.gov/monetarypolicy/bsd-content-201411.htm.

P.L. 111-203.

Between QE2 and QE3, the Fed created the Maturity Extension Program, popularly referred to as Operation Twist. Under this program, the Fed sold short-term Treasury securities and purchased long-term Treasury securities, resulting in no net increase in the size of its balance sheet.

See H.3. Federal Reserve Statistical Releases, Aggregate Reserves of Depository Institutions and the Monetary Base, at http://www.federalreserve.gov/releases/h3/Current.

For a review of studies on the effectiveness of QE, see CRS Report R42962, Federal Reserve: Unconventional Monetary Policy Options, by [author name scrubbed].

See CRS Report R43476, Returning to Full Employment: What Do the Indicators Tell Us?, by [author name scrubbed].

Federal Reserve, press release, June 18, 2014, http://federalreserve.gov/newsevents/press/monetary/20140618a.htm.

Federal Reserve, press release, October 29, 2014, available at http://federalreserve.gov/newsevents/press/monetary/20141029a.htm.

Available at http://federalreserve.gov/newsevents/press/monetary/20140917c.htm. For more information on the Fed's exit strategy, see Stanley Fischer, "Conducting Monetary Policy with a Large Balance Sheet," speech at Monetary Policy Forum, February 27, 2015, http://www.federalreserve.gov/newsevents/speech/fischer20150227a.htm; Simon Potter, "Money Markets and Monetary Policy Normalization," speech at New York University, April 15, 2015, http://www.newyorkfed.org/newsevents/speeches/2015/pot150415.html.

In the normalization statement, the Fed announced it would continue setting a target range for the federal funds rate (e.g., 0% to 0.25%), whereas before rates reached the zero bound, the Fed set a point target. See Simon Potter, "Interest Rate Control During Normalization," speech at SIFMA conference, October 7, 2014, available at http://www.newyorkfed.org/newsevents/speeches/2014/pot141007.html.

The decline in turnover in the federal funds market since the beginning of unconventional monetary policy is chronicled in Gara Afonso et al., "Who's Borrowing in the Fed Funds Market," Liberty Street Economics, Federal Reserve Bank of New York, December 9, 2013, available at http://libertystreeteconomics.newyorkfed.org/2013/12/whos-borrowing-in-the-fed-funds-market.html#more.

Fed Chair Janet Yellen, press conference, September 17, 2014, available at http://www.federalreserve.gov/mediacenter/files/FOMCpresconf20140917.pdf.

The Fed is legally forbidden from buying securities directly from the Treasury Department. Instead, it buys them on secondary markets from primary dealers.

See Federal Reserve Bank of New York, FAQs: Overnight Fixed-Rate Reverse Repurchase Agreement Operational Exercise, September 19, 2014, available at http://www.newyorkfed.org/markets/rrp_faq.html. For a list of the Fed's current counterparties, see http://www.newyorkfed.org/markets/expanded_counterparties.html. See also Josh Frost et al., "Overnight RRP Operations as a Monetary Policy Tool," Finance and Economics Discussion Series 2015-010, February 19, 2015, http://www.federalreserve.gov/econresdata/feds/2015/files/2015010pap.pdf.

The authority (12 U.S.C. 461(b)) for the Fed to pay interest on reserves was originally granted in the Financial Services Regulatory Relief Act of 2006, beginning in 2011. The start date was changed to immediately in the Emergency Economic Stabilization Act of 2008 (P.L. 110-343).

The interest rate on reserves might be expected to set a floor on the federal funds rate, but in practice the actual federal funds rate has been slightly lower than the interest rate on reserves because the Fed began paying interest in 2008. This discrepancy has been ascribed to the fact that some participants in the federal funds market, such as Fannie Mae, Freddie Mac, and the Federal Home Loan Banks, do not earn interest on reserves held at the Fed. See Gara Afonso et al., "Who's Lending in the Fed Funds Market," Liberty Street Economics, Federal Reserve Bank of New York, December 2, 2013, available at http://libertystreeteconomics.newyorkfed.org/2013/12/whos-lending-in-the-fed-funds-market.html#.VDWOgxYXOmo.

Removing reserves through asset sales would have the same effect on bank lending as paying banks to keep reserves at the Fed.

Joseph Gagnon, "Should the Fed Subsidize Banks?," blog post, Peterson Institute for International Economics, December 9, 2015, http://blogs.piie.com/realtime/?p=5299. The difference between the federal funds rate and the interest rate paid on reserves is not intentional, but comes about because of differences in eligible market participants. Gagnon proposes eliminating the difference by having the Fed offer unlimited reverse repos.

See, for example, Sheila Bair, "The Federal Reserve's Risky Reverse Repurchase Scheme," Wall Street Journal, July 24, 2014.

The Fed was assigned regulatory responsibility for thrift holding companies as a result of the Dodd-Frank Act, which eliminated the Office of Thrift Supervision.