NY Fed weighs operational options in reducing its balance sheet

Excerpts from remarks by Lorie Logan, Senior Vice President, New York Fed at the Policy Conference on Currencies, Capital, and Central Bank Balances, Stanford University

Last October, the Federal Reserve began the process of reducing the size of its balance sheet—a significant milestone in the ongoing monetary policy normalization process.  Using a program of progressively increasing caps, we are gradually reducing the Fed’s securities holdings, which will reduce the supply of reserve balances in the banking system.  This process will continue until reserves fall to a level that reflects the banking system’s demand for reserve balances and the FOMC’s decisions about how to implement monetary policy “most efficiently and effectively,” as noted in the FOMC’s Policy Normalization Principles and Plans.

However, there remains much uncertainty over what the “normal” size of the Fed’s longer-run balance sheet will be and how long it will take to get there.  This uncertainty arises from numerous sources:  We don’t know how fast our MBS holdings will pay down, how quickly currency outstanding will grow, how many bank reserves will be required for the efficient and effective execution of monetary policy, or how other liability items on the Fed’s balance sheet will evolve.  The economic outlook also poses an ever-present source of uncertainty.

The FOMC could choose to retain the floor system to implement policy in the longer-run or it could choose to shift back to a corridor system. However, a reinstated corridor system may be less familiar than some expect. Such a framework would involve uncertainties about reserve demand and greater variability in factors affecting reserve supply, and would likely require operations that are larger, more variable, or even very different from those used before the crisis. Meanwhile, those who favor a floor system may be encouraged by the performance of our current framework to date. We’ve learned that the floor system has proven to be highly effective at controlling the effective federal funds rate and other money market rates, is resilient to significant shifts in market structure, and is efficient to operate. Under either framework, the balance sheet will likely normalize at a level substantially larger than it was before the crisis to accommodate higher demand for reserves and non-reserve liabilities in the post-crisis landscape.

Read the full remarks

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