Fed Outlines Plans for Swollen Balance Sheet

In addition to the rate hike announced today, the Federal Open Market Committee released a policy statement explaining how it plans to reduce the Fed’s balance sheet, which is swollen with $4.5 trillion in securities purchased as part of the quantitative easing programs between 2008 and 2014. The committee said it would gradually reduce the Fed’s holdings by decreasing reinvestment of principal payments it receives on the securities up to specified caps.

Starting “once normalization of the federal funds rate is well under way,” the Fed will reduce its balance sheet by $6 billion in Treasury securities each month, rising in steps of $6 billion until it is rolling off $30 billion every month. The process will be similar for GSE debt and mortgage-backed securities, starting at $4 billion per month and rising to $20 billion.

The result of declining securities holdings would be a decline in reserve balances, the Fed added. “The Committee currently anticipates reducing the quantity of reserve balances, over time, to a level appreciably below that seen in recent years but larger than before the financial crisis,” the FOMC said. “The level will reflect the banking system’s demand for reserve balances and the Committee’s decisions about how to implement monetary policy most efficiently and effectively in the future.”

The FOMC added that it “expects to learn more” about underlying demand for reserves as it moves through the process of normalizing its balance sheet. It also said that the committee is prepared to resume reinvestment of principal payments should the economic outlook deteriorate further or should the economy need more stimulus than adjustments to the federal funds rate can provide.