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Board of Governors of the Federal Reserve System
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Board of Governors of the Federal Reserve System

Policy Normalization

  • Policy Normalization
  • Q&As

At its December 2015 meeting, the Federal Open Market Committee (FOMC) decided that economic conditions and the economic outlook warranted the commencement of the policy normalization process and the Committee voted to raise the target range for the federal funds rate, the first change since December 2008. The postmeeting statement announced the change in the monetary policy stance, and the accompanying implementation note provided operational details associated with the Federal Reserve's policy tools. The FOMC outlined its approach to monetary policy normalization in the Policy Normalization Principles and Plans issued after its September 2014 meeting.

Policy Normalization Principles and Plans

Over the spring and summer of 2014, the FOMC discussed ways to normalize the stance of monetary policy and the Federal Reserve's securities holdings. The discussions were part of prudent planning and did not imply that normalization would necessarily begin soon. The Committee continued to judge that many of the normalization principles that it adopted in June 2011 remained applicable. However, in light of the changes in the System Open Market Account (SOMA) portfolio since 2011 and enhancements in the tools the Committee would have available to implement policy during normalization, the Committee concluded that some aspects of the eventual normalization process would likely differ from those specified earlier. The Committee also agreed that it was appropriate to provide additional information regarding its normalization plans. In September 2014, all FOMC participants but one agreed on the following key elements of the approach they intended to implement when it became appropriate to begin normalizing the stance of monetary policy:

  • The Committee will determine the timing and pace of policy normalization--meaning steps to raise the federal funds rate and other short-term interest rates to more normal levels and to reduce the Federal Reserve's securities holdings--so as to promote its statutory mandate of maximum employment and price stability.
    • When economic conditions and the economic outlook warrant a less accommodative monetary policy, the Committee will raise its target range for the federal funds rate.
    • During normalization, the Federal Reserve intends to move the federal funds rate into the target range set by the FOMC primarily by adjusting the interest rate it pays on excess reserve balances.
    • During normalization, the Federal Reserve intends to use an overnight reverse repurchase agreement facility and other supplementary tools as needed to help control the federal funds rate. The Committee will use an overnight reverse repurchase agreement facility only to the extent necessary and will phase it out when it is no longer needed to help control the federal funds rate.
  • The Committee intends to reduce the Federal Reserve's securities holdings in a gradual and predictable manner primarily by ceasing to reinvest repayments of principal on securities held in the SOMA.
    • The Committee expects to cease or commence phasing out reinvestments after it begins increasing the target range for the federal funds rate; the timing will depend on how economic and financial conditions and the economic outlook evolve.
    • The Committee currently does not anticipate selling agency mortgage-backed securities as part of the normalization process, although limited sales might be warranted in the longer run to reduce or eliminate residual holdings. The timing and pace of any sales would be communicated to the public in advance.
  • The Committee intends that the Federal Reserve will, in the longer run, hold no more securities than necessary to implement monetary policy efficiently and effectively, and that it will hold primarily Treasury securities, thereby minimizing the effect of Federal Reserve holdings on the allocation of credit across sectors of the economy.
  • The Committee is prepared to adjust the details of its approach to policy normalization in light of economic and financial developments.

At the March 2015 FOMC meeting, all participants agreed to provide the following additional details regarding the operational approach the FOMC intended to use when it became appropriate to begin normalizing the stance of monetary policy. When economic conditions warrant the commencement of policy firming, the Federal Reserve intends to:

  • Continue to target a range for the federal funds rate that is 25 basis points wide.
  • Set the IOER rate equal to the top of the target range for the federal funds rate and set the offering rate associated with an ON RRP facility equal to the bottom of the target range for the federal funds rate.
  • Allow aggregate capacity of the ON RRP facility to be temporarily elevated to support policy implementation; adjust the IOER rate and the parameters of the ON RRP facility, and use other tools such as term operations, as necessary for appropriate monetary control, based on policymakers' assessments of the efficacy and costs of their tools. The Committee expects that it will be appropriate to reduce the capacity of the facility fairly soon after it commences policy firming.

FOMC Decision to Commence the Normalization Process

Policy Normalization Principles and Plans, September 2014

FOMC Discussions of Normalization Principles and Plans

FOMC Discussions of Normalization Leading to the Adoption of the Policy Normalization Principles and Plans in September 2014

To find out more about using ON RRP as a tool of monetary policy, see FEDS paper: Overnight RRP Operations as a Monetary Policy Tool: Some Design Considerations (PDF). For a primer on the operation of monetary policy during normalization, see FEDS paper: Monetary Policy 101: A Primer on the Fed's Changing Approach to Policy Implementation (PDF).

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Last update: December 16, 2015