FED: John Taylor Apoia a Saída Plosser

Two things are very attractive about the strategy. First, it aims to return monetary policy to one in which the federal funds rate is determined by the supply and demand for reserves. This of course requires that the Fed bring down the enormous supply of reserve balances on its balance sheet to a level closer to a quantity demanded by banks at a positive interest rate. Reserves were $26 billion on September 10, 2008 when the funds rate was 2 percent just before the panic, which gives an order of magnitude of where reserves should go. Plosser assumes $50 billion, which seems reasonable to me. But reserve balances will be around $1,500 billion by the time QEII is over, so it’s a long way down. The second attractive feature of the exit strategy is that the path of reduction in reserve balances is tied to future movements of the federal funds rate. It is thus much like an exit rule, or a contingency plan, which both preserves flexibility and creates predictability. The exit rule would reduce reserves by $125 billion for each 25 basis point increase in the funds rate plus another $50 billion at each FOMC meeting. After 10 meetings $1,450 billion would be removed (the contingency plan starts at the second meeting) bringing reserves to $50 billion.