Part 2: Monetary Policy
Monetary Policy Report submitted to the Congress on February 25, 2022, pursuant to section 2B of the Federal Reserve Act
The Federal Open Market Committee has maintained the federal funds rate near zero...
The Federal Open Market Committee (FOMC) has been providing forward guidance for the target range for the federal funds rate, indicating that the range would be maintained at 0 to 1/4 percent until specific employment and inflation criteria had been met. Consistent with that guidance, the FOMC has maintained the target range for the federal funds rate at 0 to 1/4 percent (figure 46). In December, the Committee concluded that the inflation criteria in the forward guidance had been met and the target range would be maintained until labor market conditions had reached levels consistent with the Committee's assessments of maximum employment. In January, the Committee stated that, with inflation well above 2 percent and a strong labor market, it expected it would soon be appropriate to raise the target range for the federal funds rate.
...and the Committee has gradually reduced the monthly pace of its net asset purchases of Treasury securities and agency mortgage-backed securities, which will end in early March
From June 2020 until November 2021, the Federal Reserve had been expanding its holdings of Treasury securities by $80 billion per month and its holdings of agency mortgage-backed securities (MBS) by $40 billion per month. At its November meeting, in light of the substantial further progress the economy had made toward maximum employment and price stability, the Committee decided to reduce the monthly pace of its net asset purchases by $10 billion per month for Treasury securities and by $5 billion per month for agency MBS. At its December meeting, in light of inflation developments and the further improvement in the labor market, the Committee began to reduce the monthly pace of net purchases more rapidly, by $20 billion per month for Treasury securities and by $10 billion per month for agency MBS. At its January meeting, the Committee decided to continue to reduce the monthly pace of net purchases and conclude net purchases in early March.
The FOMC will continue to monitor the implications of incoming information for the economic outlook
The Committee will continue to monitor incoming economic data and would be prepared to adjust the stance of monetary policy as appropriate to manage risks that could impede the attainment of its goals. The Committee's assessments will take into account a wide range of information, including readings on public health, labor market conditions, inflation pressures and inflation expectations, and financial and international developments. With appropriate policy, inflation is expected to decline over the course of the year as supply constraints ease and demand moderates due to waning effects of fiscal support and the removal of monetary policy accommodation. The FOMC will use its policy tools as appropriate to prevent higher inflation from becoming entrenched while promoting a sustainable expansion and strong labor market.
The Federal Reserve issued a statement regarding principles for reducing the size of its balance sheet
Following the conclusion of its January meeting, the FOMC issued a set of principles regarding its planned approach for significantly reducing the size of the Federal Reserve's balance sheet.12 With these principles, the Committee reiterated its view that changes in the target range for the federal funds rate are its primary means of adjusting the stance of monetary policy and conveyed its expectation that reducing the size of the Federal Reserve's balance sheet would occur after the process of increasing the target range for the federal funds rate had begun. The Committee also noted that it would determine the timing and pace of reductions in the size of its balance sheet so as to promote its maximum-employment and price-stability goals and that reductions would occur over time in a predictable manner, primarily by adjusting the amounts reinvested of principal payments received from securities held in the System Open Market Account (SOMA). Furthermore, the FOMC communicated that, over time, it intended to maintain securities holdings in amounts needed to implement monetary policy efficiently and effectively in its ample reserves regime. The Committee also noted that, in the longer run, it intended to hold primarily Treasury securities in the SOMA, thereby minimizing the effect of Federal Reserve holdings on the allocation of credit across sectors of the economy. Finally, the Committee emphasized that it was prepared to adjust any details of its approach in light of economic and financial developments.
The size of the Federal Reserve's balance sheet continued to grow, although at a diminished pace since November
The Federal Reserve's balance sheet has grown to $8.9 trillion from $8.1 trillion in July, reflecting continued net asset purchases of U.S. Treasury securities and agency mortgage-backed securities to support smooth market functioning and foster accommodative financial conditions, thereby supporting the flow of credit to households and businesses (figure 47). All of the Federal Reserve's emergency credit and liquidity facilities have been closed for new lending for some time, and the residual outstanding balances at those facilities have continued to decline.13
Reserve balances have changed little, on net, since July and stand near $4 trillion. Usage of the overnight reverse repurchase agreement facility increased significantly. (See the box "Developments in the Federal Reserve's Balance Sheet and Money Markets.")
The Federal Reserve established two standing repurchase agreement facilities
In July of last year, the Federal Reserve established a domestic standing repurchase agreement (repo) facility and a standing repo facility for foreign and international monetary authorities. These facilities are intended to serve as backstops in money markets to support the effective implementation of monetary policy and smooth market functioning. The rates for these facilities have been maintained at levels somewhat higher than rates in overnight funding markets, consistent with their intended roles as backstops.
Developments in the Federal Reserve's Balance Sheet and Money Markets
The size of the Federal Reserve's balance sheet increased from $4.2 trillion before the pandemic to its current level of roughly $8.9 trillion, largely reflecting an increase in System Open Market Account holdings from asset purchases (figure A). As net asset purchases have continued, albeit at a slower pace in recent months, the Federal Reserve's liabilities have also increased (figure B).1 This discussion reviews recent developments in the size and composition of the Federal Reserve's balance sheet and conditions in money markets.
The Federal Reserve's net asset purchases continued at a pace of $120 billion per month from July through October. At its November meeting—in light of the substantial further progress the economy had made toward the Federal Open Market Committee's goals since December 2020—the Committee decided to begin reducing the monthly pace of its net asset purchases by $10 billion per month for Treasury securities and $5 billion per month for agency mortgage-backed securities. At its December meeting—in light of inflation developments and further improvement in the labor market—the Committee decided to double the pace of reductions in its net asset purchases, implying that increases in securities holdings would cease by mid-March. The Federal Reserve's net asset purchases since July 2021 have led to an $813 billion increase in its total assets (figure C).
C. Balance sheet comparison
(Billions of dollars)
| February 16, 2022 | July 7, 2021 | Change | |
|---|---|---|---|
| Assets | |||
| Total securities | |||
| Treasury securities | 5,739 | 5,202 | 537 |
| Agency debt and MBS | 2,707 | 2,322 | 385 |
| Net unamortized premiums | 350 | 351 | -1 |
| Repurchase agreements | 0 | 0 | 0 |
| Loans and lending facilities | |||
| PPPLF | 28 | 88 | -60 |
| Other loans and lending facilities | 40 | 72 | -32 |
| Central bank liquidity swaps | 0 | 1 | -1 |
| Other assets | 48 | 61 | -13 |
| Total assets | 8,911 | 8,098 | 813 |
| Liabilities and capital | |||
| Federal Reserve notes | 2,185 | 2,139 | 45 |
| Reserves held by depository institutions | 3,797 | 3,856 | -59 |
| Reverse repurchase agreements | |||
| Foreign official and international accounts | 257 | 264 | -7 |
| Others | 1,644 | 786 | 858 |
| U.S. Treasury General Account | 709 | 725 | -16 |
| Other deposits | 251 | 237 | 14 |
| Other liabilities and capital | 67 | 91 | -24 |
| Total liabilities and capital | 8,911 | 8,098 | 813 |
Note: MBS is mortgage-backed securities. PPPLF is Paycheck Protection Program Liquidity Facility.
Source: Federal Reserve Board, Statistical Release H.4.1, "Factors Affecting Reserve Balances."
Federal Reserve liabilities increased in line with changes in its assets. The level of reserve balances was little changed, on net, while other liabilities—most notably the overnight reverse repurchase agreements (ON RRP)—increased substantially. Another Federal Reserve liability—balances maintained in the Treasury General Account (TGA)—varied significantly over recent months in connection with developments related to the debt limit. The U.S. Treasury lowered its outstanding balance in the TGA from $725 billion in the beginning of July 2021 to a low of $42 billion on December 16, 2021. Following the debt limit resolution on December 16, 2021, which raised the debt limit of the U.S. government, both net Treasury bill issuance and the TGA balance increased to more normal levels.2
Money markets continued to function smoothly amid these developments, with ample liquidity putting broad downward pressure on short-term interest rates. In addition, the limited supply of Treasury bills during the debt limit episode pushed bill yields lower. In this environment of ample liquidity, limited Treasury bill supply, and low repurchase agreement rates, the ON RRP facility continued to serve its intended purpose of helping to provide a floor under short-term interest rates and support effective implementation of monetary policy.3 Usage of the facility has nearly doubled, on average, since early July, primarily driven by greater participation from government money market funds.4 The ON RRP take-up reached a record high of $1.9 trillion on year-end before retracing to around $1.6 trillion in early January.
1. For general explanations of several liabilities on the Federal Reserve's balance sheet, see the box "The Role of Liabilities in Determining the Size of the Federal Reserve's Balance Sheet" in Board of Governors of the Federal Reserve System (2019), Monetary Policy Report (Washington: Board of Governors, February), pp. 41–43, https://www.federalreserve.gov/monetarypolicy/files/20190222_mprfullreport.pdf. Return to text
2. For details, see U.S. Congress, Senate (2021), "A Joint Resolution Relating to Increasing the Debt Limit," S.J. Res., 117 Cong. Congressional Record (daily edition), vol. 167, December 14, pp. S 9134–53, https://www.congress.gov/bill/117th-congress/senate-joint-resolution/33. Return to text
3. The ON RRP facility helps keep the effective federal funds rate from falling below the target range set by the Federal Open Market Committee, as institutions with access to the ON RRP should be unwilling to lend funds below the ON RRP's preannounced offering rate. The ON RRP facility is primarily used by nonbank counterparties such as money market funds. The rate offered through the ON RRP facility complements the interest on reserve balances rate in supporting effective monetary policy implementation. Return to text
4. In light of the potential for expanded use of the facility and given growth in money market fund assets under management in recent years, the Federal Open Market Committee raised the per-counterparty cap on ON RRP participation to $160 billion per day from $80 billion at its September 2021 meeting. Return to text
Footnotes
12. See the January 26, 2022, press release regarding the Principles for Reducing the Size of the Federal Reserve's Balance Sheet, available at https://www.federalreserve.gov/newsevents/pressreleases/monetary20220126c.htm. Return to text
13. A list of credit and liquidity facilities established by the Federal Reserve in response to COVID-19 is available on the Federal Reserve's website at https://www.federalreserve.gov/funding-credit-liquidity-and-loan-facilities.htm. Return to text