Q&As

 

Why did the Federal Open Market Committee (FOMC) revise its Balance Sheet Normalization Principles and Plans in March 2019?

At its January 2019 meeting, the FOMC decided to continue operating in the current regime in which active management of the supply of reserve balances is not required. Then, why do the revised Balance Sheet Normalization Principles and Plans indicate that reserve balances will continue to decline even after balance sheet runoff ends?

What level of reserve balances does the FOMC expect to be consistent with efficient and effective implementation of monetary policy?

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?

Why does the FOMC's guidance from its January 2019 meeting 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 composition of its securities holdings?

The revised Balance Sheet Normalization Principles and Plans discuss the possibility of selling agency MBS. When might this occur?

Why did the revised Balance Sheet Normalization Principles and Plans retain a redemption cap for agency MBS?

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?

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 FOMC?

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

Why did the Federal Open Market Committee (FOMC) revise its Balance Sheet Normalization Principles and Plans in March 2019?

After careful deliberations over several meetings, the Committee decided in January 2019 that it would continue to operate in an ample reserves regime in the longer run. The Committee previously noted that it would hold no more securities than necessary in the longer run to foster efficient and effective monetary policy implementation. In January, many FOMC participants judged that the size of the balance sheet could be approaching this level by later this year and that it would be appropriate to provide more information to the public soon about how the FOMC envisions completing the normalization of the size of the balance sheet. At its March 2019 meeting, the Committee followed up on this discussion by issuing the Balance Sheet Normalization Principles and Plans (BSNPP). The BSNPP describes the Committee's plans for slowing the pace of the decline in the size of the balance sheet over coming months and ending the reduction in the size of the balance sheet at the end of September. The BSNPP also provides some additional information about the evolution of the balance sheet after September. Making this information available now should help provide greater clarity about the future path of the Federal Reserve's balance sheet and foster a smooth transition to the long-run ample reserves operating regime.

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At its January 2019 meeting, the FOMC decided to continue operating in the current regime in which active management of the supply of reserve balances is not required. Then, why do the revised Balance Sheet Normalization Principles and Plans indicate that reserve balances will continue to decline even after balance sheet runoff ends?

The Federal Reserve intends to continue to implement monetary policy in the current operating framework in which an ample supply of reserves ensures that control over the level of the federal funds rate and other short-term interest rates is exercised primarily by setting the Federal Reserve's administered rates and in which active management of the supply of reserves is not required. The FOMC has also long stated its intention that the Federal Reserve will, in the longer run, hold no more securities than necessary to implement monetary policy efficiently and effectively, which in turn implies that the supply of reserves should be no more than what is needed to operate efficiently and effectively in an ample reserves framework.

The Committee expects that reserves will likely be somewhat larger than necessary when balance sheet runoff ends in September 2019. After that time, the average level of reserves will continue to decline, albeit at a very gradual pace reflecting trend growth in currency and other nonreserve liabilities on the Federal Reserve's balance sheet. That very gradual average decline will allow reserve balances to reach a level consistent with efficient and effective implementation of policy with little risk that reserve balances could drift too low.

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What level of reserve balances does the FOMC expect to be consistent with efficient and effective implementation of monetary policy?

The FOMC will be learning about the underlying demand for reserves over time. The plan to very gradually reduce the level of reserves after September should allow the Committee to reach the appropriate level while minimizing any risks of allowing reserves to drop too low. If notable signs of reserve scarcity were encountered before September, the FOMC would be prepared to adjust its plans as appropriate.

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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 operating regime for monetary policy has been working very well. In particular, the regime--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 by setting 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.

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Why does the FOMC's guidance from its January 2019 meeting 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 the idea 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, balance sheet normalization had not yet begun, and the FOMC established a relatively high bar for changes to its balance sheet plans to reinforce its determination 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.

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When will the FOMC provide additional information about its plans for the Federal Reserve's balance sheet, such as the desired composition of its securities holdings?

As noted previously, the FOMC expects that the Federal Reserve's balance sheet in the longer run will consist primarily of Treasury securities. The current guidance is consistent with that principle in that after September 2019, principal payments on agency debt and agency mortgage-backed securities (MBS) will be reinvested in Treasury securities, except in the unlikely event that those payments exceed the current cap on MBS redemptions of $20 billion per month. The Committee will continue to discuss issues related to the longer-run composition of its securities portfolio at upcoming meetings.

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The revised Balance Sheet Normalization Principles and Plans discuss the possibility of selling agency MBS. When might this occur?

The FOMC's previous communications on balance sheet normalization have long indicated that the Federal Reserve might consider a program of MBS sales at some point to reduce or eliminate residual holdings of agency MBS. A program of that sort might be established in the future, but it would be announced well in advance and would be carefully designed to avoid any significant effects on financial markets.

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Why did the revised Balance Sheet Normalization Principles and Plans retain a redemption cap for agency MBS?

In the unlikely scenario in which principal payments on agency debt and agency MBS holdings exceed $20 billion in any month, the Federal Reserve will invest the amount in excess of $20 billion in agency MBS. This is a continuation of one feature of the balance sheet normalization program that started in October 2017 and it helps limit the pace at which the Federal Reserve's MBS holdings could decline if prepayments accelerated in response to a sizable decline in interest rates.

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 pre-specified caps. Since their inception in October 2017, the caps rose gradually at three-month intervals over a 12-month period, and their maximum values, which were reached in October 2018, were subsequently maintained. For further information on reinvestments, 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?

The Federal Reserve's assets always equal its liabilities plus capital; when assets are reduced, some liability must also fall. Generally speaking, a reduction in the Federal Reserve's assets does not affect its nonreserve liabilities, such as currency in circulation. Therefore, a reduction in assets causes bank reserve balances to fall. 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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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 FOMC?

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 has set the offering rate associated with this facility equal to the bottom of the target range for the federal funds rate. The Federal Reserve adjusts the IOER rate and the parameters of the ON RRP facility and uses other tools such as term operations, as necessary for appropriate monetary control, based on policymakers' assessments of the efficacy and costs of their tools.

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.

To find out more about monetary policy implementation 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 post-meeting 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 FOMC in its post-meeting statement. This step was intended to help increase public awareness and understanding about the implementation 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 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 post-meeting statements and other FOMC materials, are available on the FOMC calendar page of the Federal Reserve's web site.

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Last Update: March 20, 2019