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Informing the public about the Federal Reserve
How will the Federal Reserve ensure that the size of its balance sheet won’t lead to excessive inflation?
Since the financial crisis, the Federal Open Market Committee (FOMC) has undertaken a highly accommodative monetary policy. In addition to maintaining an exceptionally low level for the federal funds rate, the Committee has expanded the Federal Reserve's holdings of longer-term securities as a means to put downward pressure on longer-term interest rates and make broader financial conditions more accommodative. These actions have helped to support a stronger economic recovery and ensure that inflation, over time, is at levels consistent with the Committee's mandate to maintain maximum employment and stable prices. The FOMC monitors the stance of monetary policy, the economic outlook, and financial developments closely. The Committee has the tools it needs to tighten monetary policy at the appropriate time and will adjust its policy tools as necessary to achieve its mandate. The ability to pay interest on reserve balances (deposits held by banks and other depository institutions in their accounts at the Federal Reserve) is an important tool that the Federal Reserve can use to help raise the level of short-term interest rates, even with elevated levels of reserves. For example, if the Federal Reserve raises the interest rate it pays on reserves, then banks should generally be unwilling to lend to their customers at a lower rate. In addition, the Federal Reserve has developed new tools such as reverse repurchase operations, designed to aid in reducing the large quantity of reserves currently held by the banking system. Finally, policymakers have indicated that they would pursue the gradual sale of securities on the Fed's balance sheet once the economic recovery is firmly established. The FOMC's strategy for employing these tools to remove accommodation at the appropriate time is discussed in the minutes of the June 2011 FOMC meeting.
