Q&As

 

Why did the FOMC decide in January 2019 to retain the current operating regime for monetary policy in which active management of the supply of reserve balances is not required rather than return to the operating regime that was in place prior to the Global Financial Crisis?

What does the FOMC's January 2019 decision imply about the future for the Federal Reserve’s balance sheet and the longer-run level of reserves balances?

Why does the FOMC's guidance indicate that it might change the details for balance sheet normalization "in light of economic and financial developments"? Isn't this a much lower bar than the Committee had established with the 2017 guidance, which suggested that it would take a "material" change in the economic outlook that would warrant a "substantial" decline in the funds rate before a change to normalization plans?

When will the FOMC provide additional information about its plans for the Federal Reserve's balance sheet, such as the desired stopping point for asset reductions or the composition of assets?

How have the FOMC's plans for decreasing reinvestments--announced after the June 2017 FOMC meeting and initiated in October 2017--gradually reduced the Federal Reserve’s holdings of Treasury securities, agency debt, and agency mortgage-backed securities?

How does a reduction in the Federal Reserve's holdings of Treasury securities, agency debt, and agency mortgage-backed securities translate to a reduction in the reserve balances held by banks?

During normalization, how are the interest rate on excess reserves (IOER), the overnight reverse repurchase agreement (ON RRP) facility, and other policy tools used to move the federal funds rate into the target range set by the Federal Open Market Committee (FOMC)?

What is the Federal Reserve's "Decisions Regarding Monetary Policy Implementation"--the implementation note--and how does it differ from the FOMC's postmeeting statement?

Will the Federal Reserve sell securities as part of the monetary policy normalization process?
 

Why did the FOMC decide in January 2019 to retain the current operating regime for monetary policy in which active management of the supply of reserve balances is not required rather than return to the operating regime that was in place prior to the Global Financial Crisis?

The current implementation framework for monetary policy has been working very well. In particular, the framework--in which an ample supply of reserve balances ensures that control over the level of the federal funds rate and other short-term interest rates is exercised primarily through the setting of the Federal Reserve's administered rates and active management of the supply of reserve balances is not required--is simple to operate, provides good control over short-term interest rates, and is effective in a wide range of economic environments. The decision to retain the current implementation framework is the culmination of discussions and careful planning by the Committee over an extended period.

What does the FOMC's January 2019 decision imply about the future for the Federal Reserve’s balance sheet and the longer-run level of reserves balances?

Conceptually, the FOMC expects to reach a level of reserve balances that comfortably meets the banking system's demand for reserves plus a buffer of reserves on top of that level. The buffer will help to ensure that the level of the federal funds rate will be well insulated from daily swings in reserve demand and reserve supply factors.

It is very difficult to pin down the precise quantity of reserve balances that will be necessary for the efficient and effective implementation of monetary policy. The FOMC will be learning over coming months about the underlying demand for reserves.

Why does the FOMC's guidance indicate that it might change the details for balance sheet normalization "in light of economic and financial developments"? Isn't this a much lower bar than the Committee had established with the 2017 guidance, which suggested that it would take a "material" change in the economic outlook that would warrant a "substantial" decline in the funds rate before a change to normalization plans?

The new guidance about openness to adjusting the details of balance sheet plans in light of economic and financial developments is simply intended to convey that the Committee would never want balance sheet normalization to work at cross purposes with changes in the federal funds rate. At the time of its previous communications, the balance sheet normalization had not yet begun and the FOMC established a relatively high bar for changes to its balance sheet plans to reinforce that the federal funds rate is the Committee's principal tool for adjusting the stance of monetary policy. Balance sheet normalization, by contrast, was intended to be a mostly mechanical process that would take place in the background. It continues to be the case that the target range for the federal funds rate is the Committee’s principal tool for adjusting the stance of monetary policy.

When will the FOMC provide additional information about its plans for the Federal Reserve's balance sheet, such as the desired stopping point for asset reductions or the composition of assets?

The Committee has discussed those issues at recent meetings and expects to be able to provide additional details on aspects of the normalization of the balance sheet relatively soon.

How have the FOMC's plans for decreasing reinvestments--announced after the June 2017 FOMC meeting and initiated in October 2017--gradually reduced the Federal Reserve’s holdings of Treasury securities, agency debt, and agency mortgage-backed securities?

The Committee has been gradually reducing the Federal Reserve's holdings of Treasury securities and agency securities--agency debt and agency mortgage-backed securities (MBS)--by decreasing the reinvestment of the principal payments it receives from securities holdings. Each month, such payments are reinvested only to the extent that they exceed a pre-specified cap. The caps rose gradually at three-month intervals over a 12-month period and the maximum value of the caps at the end of the 12-month period has been maintained.

The table below provides an illustrative example of how the Federal Reserve's holdings of Treasury and agency securities declined each month beginning in October 2017. To make the presentation as simple as possible, the example assumes maturing Treasury and agency securities of the amounts in columns (1) and (6), with columns (2) and (7) showing the assumed caps applicable in each month. Given these assumptions, the remaining columns of the table report values for the monthly redemptions and reinvestments of securities as well as the corresponding decline in the Federal Reserve's securities holdings.

For example, in the first month, as shown in the first row of the table, the Treasury cap is set at $6 billion (column 2) and principal payments from maturing Treasury securities total $20 billion (column 1). In this case, the Federal Reserve would reinvest $14 billion of the maturing Treasury securities (column 4) and redeem $6 billion of maturing Treasury securities (column 3). As a result, the Federal Reserve's Treasury holdings (column 5) decline by $6 billion from the assumed initial value of $2,500 to $2,494.

In the case of agency securities, the cap is initially set at $4 billion (column 7) and principal payments in the first month are assumed to be $15 billion (column 6). In this case, the Federal Reserve would reinvest $11 billion in new agency securities (column 9) and redeem $4 billion (column 8), resulting in a decline in the Federal Reserve's agency holdings of $4 billion from $1,500 billion to $1,494 billion (column 10).

The Treasury cap is binding in each of the first 9 months of this example. As a result, Treasury redemptions are equal to the value of the cap, and the remaining value of maturing Treasury securities in excess of the cap are reinvested. In month 10, the cap is larger than the value of maturing Treasury securities and there is no reinvestment. After 12 months, the maximum cap has been reached; thereafter, in this example, the Treasury cap is not binding in months 13 and 16. Columns 8 and 9 report the same information for agency securities. As principal payments of agency securities are expected to decline over time in this example, while the cap increases, reinvestments fall to zero by month 7.

(in billions of dollars)

Month Maturing Treasury Securities
(1)
Cap
(2)
Redemptions
(3)=minimum of (1), (2)
Reinvestments
(4)=(1)-(3)
Memo: Treasury Holdings
(5)
Agency Securities Principal Payments
(6)
Cap
(7)
Redemptions
(8)=minimum of (6), (7)
Reinvestments
(9)=(6)-(8)
Memo: Agency Holdings
(10)
SOMA Holdings
(11)=(5)+(10)
Assumed value of holdings in month before change in reinvestment policy 2500         1500 4000
1 20 6 6 14 2494 15 4 4 11 1496 3990
2 30 6 6 24 2488 15 4 4 11 1492 3980
3 40 6 6 34 2482 15 4 4 11 1488 3970
4 20 12 12 8 2470 15 8 8 7 1480 3950
5 30 12 12 18 2458 15 8 8 7 1472 3930
6 40 12 12 28 2446 15 8 8 7 1464 3910
7 20 18 18 2 2428 12 12 12 0 1452 3880
8 30 18 18 12 2410 12 12 12 0 1440 3850
9 40 18 18 22 2392 12 12 12 0 1428 3820
10 20 24 20 0 2372 12 16 12 0 1416 3788
11 30 24 24 6 2348 12 16 12 0 1404 3752
12 40 24 24 16 2324 12 16 12 0 1392 3716
13 20 30 20 0 2304 10 20 10 0 1382 3686
14 30 30 30 0 2274 10 20 10 0 1372 3646
15 40 30 30 10 2244 10 20 10 0 1362 3606
16 20 30 20 0 2224 10 20 10 0 1352 3576
17 30 30 30 0 2194 10 20 10 0 1342 3536
18 40 30 30 10 2164 10 20 10 0 1332 3496
19 . . . . . . . . . . .
20 . . . . . . . . . . .
21 . . . . . . . . . . .
22 . . . . . . . . . . .
23 . . . . . . . . . . .
24 . . . . . . . . . . .

The actual size of principal payments of maturing Treasury and agency securities have differed from what is reported in this illustrative example. To better understand the expected payments on the Federal Reserve's Treasury and agency securities holdings, see

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How does a reduction in the Federal Reserve’s holdings of Treasury securities, agency debt, and agency mortgage-backed securities translate to a reduction in the reserve balances held by banks?

To see the link between a reduction in the Fed’s asset holdings and reserve balances--balances that banks maintain at the Fed--consider the evolution of a simplified version of the Fed’s balance sheet. Table 1 provides an illustrative example of the Fed's balance sheet one month before the reduction in securities holdings that results when the Fed does not reinvest principal payments. For simplicity, we assume that total assets comprise securities holdings only, of which $2,500 billion are Treasury securities and $1,500 billion are agency securities--agency securities consist of agency debt and agency mortgage-backed securities (MBS). Assets equal liabilities plus capital. In terms of liabilities, we assume reserve balances are $2,000 billion, the checking account that the Treasury holds at the Fed--the Treasury General Account (TGA)--is $100 billion and deposits of government-sponsored enterprises (GSEs) are $100 billion. (The Federal Reserve publishes its full balance sheet each week in the H.4.1 statistical release.)

Table 1. Hypothetical Fed Balance Sheet month before principal payments (in billions of dollars)
Assets Liabilities
Treasury Securities 2500 Reserve Balances 2000
MBS and agency debt Securities 1500 Treasury, General Account 100
    Deposits, GSEs 100
    Other Liabilities and Capital 1800
Total 4000   4000

Now assume that the Fed redeems and does not reinvest $6 billion in Treasury securities and $4 billion in agency MBS securities when payments on those securities are received. The Treasury and GSEs need to have cash on hand to make these payments to the Fed. The Treasury can raise cash by issuing $6 billion in new securities to the public. GSEs' cash holdings will increase by $4 billion as they receive payments on the underlying securities from mortgage holders. The cash buildup by the Treasury and the GSEs could result from the withdrawal of funds by the public from their bank accounts, which would reduce reserve balances. Overall, as shown in table 2, the Fed’s balance sheet immediately before receiving principal payments will have a reshuffling of liabilities reflecting the buildup of cash in the Treasury and GSE accounts.

Table 2. Hypothetical Fed Balance Sheet shortly before principal payments (in billions of dollars)
Assets Liabilities
Treasury Securities 2500 Reserve Balances 1990
MBS and agency debt Securities 1500 Treasury, General Account 106
    Deposits, GSEs 104
    Other Liabilities and Capital 1800
Total 4000   4000

Table 3 reflects the Fed's balance sheet after the principal payments have been received. The Fed's securities holdings decline by $10 billion, to $3,990 billion. The Treasury and GSE accounts return to their initial values, while reserve balances remain at their lower $1990 billion level. After this process is complete, reductions in Fed assets are matched dollar-for-dollar by a reduction in reserve balances.

Table 3. Hypothetical Fed Balance Sheet month after principal payments (in billions of dollars)
Assets Liabilities
Treasury Securities 2494 Reserve Balances 1990
MBS and agency debt Securities 1496 Treasury, General Account 100
    Deposits, GSEs 100
    Other Liabilities and Capital 1800
Total 3990   3990

For a detailed discussion of the accounting of how reductions in Federal Reserve holdings may affect reserve balances see the FEDS paper: How does the Fed adjust its Securities Holdings and Who is Affected? (PDF)

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During normalization, how are the interest rate on excess reserves (IOER), the overnight reverse repurchase agreement (ON RRP) facility, and other policy tools used to move the federal funds rate into the target range set by the Federal Open Market Committee (FOMC)?

During normalization, the Federal Reserve continues to target a range for the federal funds rate that is 25 basis points wide and moves the federal funds rate into the target range set by the FOMC primarily by adjusting the interest rate it pays on excess reserve balances. The Committee uses an ON RRP facility as a supplementary tool to help control the federal funds rate and set the offering rate associated with this facility equal to the bottom of the target range for the federal funds rate. When it begins to normalize the stance of monetary policy, the Federal Reserve intends initially to allow the aggregate capacity of the ON RRP facility to be limited only by the value of Treasury securities held outright in the System Open Market Account that are available for such operations in order to support policy implementation. The Federal Reserve adjusts 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 ON RRP facility fairly soon after it commences policy firming.

By paying interest on reserves and offering ON RRPs, the Federal Reserve provides safe, liquid investments for banking institutions and its ON RRP counterparties. The availability of these investments puts upward pressure on short-term market rates, including the federal funds rate, as investors are less willing to accept a lower rate elsewhere. Other supplementary tools, such as term deposits offered through the Federal Reserve's Term Deposit Facility (TDF) and term reverse repurchase agreements could also be used, if needed, to put upward pressure on money market interest rates and so help to control the federal funds rate.

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

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What is the Federal Reserve's "Decisions Regarding Monetary Policy Implementation"--the implementation note--and how does it differ from the FOMC's postmeeting statement?

When the Federal Reserve began the policy normalization process in December 2015 by increasing its target for the federal funds rate for the first time since the financial crisis, it began issuing a note that reports the decisions the Federal Reserve has taken to implement the monetary policy stance announced by the Federal Open Market Committee (FOMC) in its postmeeting statement. This step is intended to help increase public awareness and understanding about the normalization of monetary policy.

The implementation note provides the operational settings of the Federal Reserve's policy tools, including the interest rate paid on required and excess reserve balances, the offering rate on the Federal Reserve's overnight reverse repurchase agreements (ON RRPs), and the capacity of the ON RRP facility. In addition, the implementation note reports the primary credit rate charged on borrowing from the discount window. The settings of any other policy implementation tools that the Federal Reserve may decide to use during the normalization process would also be discussed in the implementation note.

When policymakers change the settings of the Federal Reserve's operational tools, a revised implementation note is issued. The implementation notes, together with the Committee's postmeeting statements and other FOMC materials, are available on the FOMC calendar page of the Federal Reserve's web site.

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Will the Federal Reserve sell securities as part of the monetary policy normalization process?

The FOMC 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 System Open Market Account (SOMA) portfolio. 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. Over the longer run, the Committee intends that the Federal Reserve will 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.

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Last Update: January 30, 2019