Discussion Paper Series 2014-E-8

Monetary Policy as a Carry Trade

Marvin Goodfriend

Quantitative monetary policy at the zero interest bound should be understood as a “bond market carry trade.” Net interest earnings on the front end of the monetary carry trade should be retained―to guard against the central bank having to create reserves (or borrow) to pay interest on reserves or managed liabilities on the back end, and to show that interest expenses are paid for in large part by earnings from the front end. In the United States, the Federal Reserve balance sheet reflects the front end of a carry trade in that by the end of 2014, about $3 trillion of reserves paying 0.25% will finance (carry) a like quantity of security holdings averaging 10 years or more in maturity earning 2.5%. The Fed has long asserted independent authority to retain net interest income thought necessary as surplus capital against prospective exposures on its balance sheet. The Fed recognizes that the retention of net interest earnings to build up surplus capital incurs no resource cost for the Treasury or taxpayers. Yet, the Fed has chosen not to build up surplus capital against the carry trade exposure and risk on its balance sheet, jeopardizing the operational credibility of monetary policy for price stability.

Keywords: bond market carry trade; Federal Reserve surplus capital; Federal Reserve Treasury remittances; inflation objective; interest on reserves; monetary policy at the zero interest bound; term premium

Views expressed in the paper are those of the authors and do not necessarily reflect those of the Bank of Japan or Institute for Monetary and Economic Studies.

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