Fed Isn't Ready to Cut Balance Sheet Yet
February 23 2017 - 5:58PM
Dow Jones News
By Kate Davidson
Top Federal Reserve officials are in no hurry to reduce their
huge portfolio of securities and other assets, effectively pushing
back on several regional Fed bank presidents who have suggested
starting the process this year.
Recent comments by Fed Chairwoman Janet Yellen and other senior
Fed leaders show they are more inclined to hold off for a
while.
The Fed built up its big portfolio, to $4.5 trillion today from
less than $1 trillion before the financial crisis, through three
rounds of bond-buying aimed at spurring the economy by lowering
long-term interest rates. Shrinking those holdings, often called
the balance sheet, could send those rates higher and trigger
turbulence in financial markets that could reverberate through the
economy.
"The simple fact is there is no playbook for shrinking the
balance sheet, there's no way of knowing what the economy's
reaction will be," said Ian Shepherdson, chief economist for
Pantheon Macreconomics. "Why take that chance of potential upset in
the real economy, via a market reaction, if you don't have to?"
The Fed has said it won't start shrinking the balance sheet
until its short-term rate increases are "well under way," but has
never defined the term. Ms. Yellen and other officials have said
they want enough room to cut their benchmark federal-funds rate to
calm markets if they react negatively or to boost the economy if it
falters. The rate is now in a low range between 0.5% and 0.75%.
Ms. Yellen told lawmakers last week Fed officials would hold the
balance sheet steady until "we have confidence that the economy is
on a solid course and the federal-funds rate has reached levels
where we have some ability to address weakness by cutting it."
When asked how high was high enough, she demurred, saying there
was no "unique level" that would trigger that process.
She also threw cold water on the suggestion, floated recently by
some of her colleagues, that Fed officials may use the balance
sheet as a tool for tightening monetary policy in conjunction with
increases in short-term interest rates.
The fed-funds rate "is our traditional tool, it's the one that
we have the most confidence in, that markets best understand how we
set it and we have the greatest confidence in our ability to
calibrate it relative to the needs of the economy," Ms. Yellen
said.
Fed governor Jerome Powell echoed her remarks Wednesday, saying
the central bank should rely on interest rates as its main policy
tool "as much as possible," and should be "well away from zero"
before allowing the balance sheet to shrink.
"I would want to be in a position where the committee is in a
place to respond to any downturn that might happen in a significant
way," he said. "I can't give you a specific number or time."
San Francisco Fed President John Williams, a close ally of Ms.
Yellen, said earlier this week that the central bank needs to gain
some "maneuvering room" with short-term rates before taking steps
to reduce the balance sheet lower, noting that a decline "will slow
the economy a little bit."
Several presidents see the issue as ripe for discussion, saying
that reducing the portfolio could give them the option to expand it
later in response to an economic downturn, and could allow them to
tighten financial conditions without boosting the dollar, which
weighs on inflation and exports.
The Fed is likely to raise the fed-funds rate above 1% "sometime
this year," Philadelphia Fed President Patrick Harker said Jan. 20.
Once that happens, "the next step" is to do something to allow the
balance sheet to start shrinking, he said. Boston Fed President
Eric Rosengren has also expressed sympathy for the idea.
St. Louis Fed President James Bullard said in a December
interview that this year "might be a good time" to start the
process.
The minutes of the Fed's Jan. 31-Feb. 1 meeting showed officials
agreed to begin conversations on the balance-sheet issue at
upcoming meetings.
In their latest forecasts issued in December, Fed officials
projected the fed-funds rate would reach 1.4% by year's end,
implying three quarter-percentage-point rate increases in 2017.
Officials have said their first step toward shrinking the
balance sheet would be to end the practice of using proceeds from
maturing bonds to buy new ones. But they haven't decided exactly
how they will do it.
Republicans in Congress have urged Ms. Yellen to begin the
process sooner rather than later and pressed her for more details
about the Fed's plans.
Write to Kate Davidson at kate.davidson@wsj.com
(END) Dow Jones Newswires
February 23, 2017 17:43 ET (22:43 GMT)
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