–A Few Members Said May Need Tightening ‘Sooner than Anticipated’
–First Tightening Step Should Be an End to Reinvestment,Extended Period
By Steven K. Beckner
“The SOMA portfolio could be reduced by selling securities
outright, by ceasing the reinvestment of principal payments on its
securities holdings, or both.”
* Second, “the extent to which the Committee might choose to vary
the pace of any asset sales it undertakes in response to economic and
financial conditions.”
“If it chose to make the pace of sales quite responsive to
conditions, the FOMC would be able to actively use two policy
instruments — asset sales and the federal funds rate target — to
pursue its economic objectives, which could increase the scope and
flexibility for adjusting financial conditions. In contrast, sales at a
pace that varied less with changes in economic and financial conditions
and was preannounced and largely predetermined would leave the federal
funds rate target as the Committee’s primary active policy instrument,
which could result in policy that is more straightforward for the
Committee to calibrate and to communicate.”
* Third, “the Committee would need to decide if and when to use the
tools that it has developed to temporarily reduce reserve balances —
reverse repurchase agreements and term deposits — in order to tighten
the correspondence between any changes in the interest rate the Federal
Reserve pays on excess reserves and the changes in the federal funds
rate.”
Following the staff presentation, the ensuing discussion led to
agreement on “several principles that would guide the Committee’s
strategy for normalizing monetary policy,” the minutes say:
* First, policy steps would be driven by the Fed’s dual mandate to
pursue maximum employment and price stability.
* Second, “to normalize the conduct of monetary policy, it was
agreed that the size of the SOMA’s securities portfolio would be reduced
over the intermediate term to a level consistent with the implementation
of monetary policy through the management of the federal funds rate
rather than through variation in the size or composition of the Federal
Reserve’s balance sheet.”
* Third, “over the intermediate term, the exit strategy would
involve returning the SOMA to holding essentially only Treasury
securities in order to minimize the extent to which the Federal Reserve
portfolio might affect the allocation of credit across sectors of the
economy. Such a shift was seen as requiring sales of agency securities
at some point.”
* Fourth, “asset sales would be implemented within a framework that
had been communicated to the public in advance, and at a pace that
potentially could be adjusted in response to changes in economic or
financial conditions.”
* Fifth, “nearly all participants indicated that the first step
toward normalization should be ceasing to reinvest payments of principal
on agency securities and, simultaneously or soon after, ceasing to
reinvest principal payments on Treasury securities.”
“Most participants viewed halting reinvestments as a way to begin
to gradually reduce the size of the balance sheet,” the minutes say. “It
was noted, however, that ending reinvestments would constitute a modest
step toward policy tightening, implying that that decision should be
made in the context of the economic outlook and the Committee’s policy
objectives.”
It was further agreed that “changes in the statement language
regarding forward policy guidance would need to accompany the
normalization process” — an obvious reference to the “extended period.”
There were different views expressed, but “most participants
indicated that once asset sales became appropriate, such sales should be
put on a largely predetermined and preannounced path; however, many of
those participants noted that the pace of sales could nonetheless be
adjusted in response to material changes in the economic outlook.”
By contrast, the minutes say that “several other participants
preferred instead that the pace of sales be a key policy tool and be
varied actively in response to changes in the outlook.”
The minutes also say that “a majority of participants preferred
that sales of agency securities come after the first increase in the
FOMC’s target for short-term interest rates, and many of those
participants also expressed a preference that the sales proceed
relatively gradually, returning the SOMA’s composition to all Treasury
securities over perhaps five years.”
A tantalizing trade-off between assets sales and rate hikes was
entertained.
“Participants noted that, for any given degree of policy
tightening, more-gradual sales that commenced later in the normalization
process would allow for an earlier increase of the federal funds rate
target from its effective lower bound than would be the case if asset
sales commenced earlier and at a more rapid pace,” the minutes say.
“As a result, the Committee would later have the option of easing
policy with an interest rate cut if economic conditions then warranted,”
they continue. “An earlier increase in the federal funds rate was also
mentioned as helpful to limit the potential for the very low level of
that rate to encourage financial imbalances.”
The minutes say “a few participants expressed a preference that
sales begin before any increase in the federal funds rate target, and a
few other participants indicated that sales and increases in the federal
funds rate target should commence at the same time.”
“The participants who favored earlier sales also generally
indicated a preference for relatively rapid sales, with some suggesting
that agency securities in the SOMA be reduced to zero over as little as
one or two years,” the minutes continue. “Such an approach was viewed as
allowing for a faster return to a normal policy environment, potentially
reducing any upside risks to inflation stemming from outsized reserve
balances, and more quickly eliminating any effects of SOMA holdings of
agency securities on the allocation of credit.”
But that’s not what the majority wanted.
“Most participants saw changes in the target for the federal funds
rate as the preferred active tool for tightening monetary policy when
appropriate,” the minutes report.
To make sure the funds rate would be an effective tool when it
comes time to use it, “a number of participants noted that it would be
advisable to begin using the temporary reserves-draining tools in
advance of an increase in the Committee’s federal funds rate target…”
It was felt that doing some advance reserve draining “would put the
Federal Reserve in a better position to assess the effectiveness of the
draining tools and judge the size of draining operations that might be
required to support changes in the interest on excess reserves (IOER)
rate in implementing a desired increase in short-term rates.”
Although most FOMC members preferred starting with rate hikes and
delaying asset sales, the minutes say “a number” said “they would be
prepared to sell securities sooner if the temporary reserves draining
operations and the end of the reinvestment of principal payments were
not sufficient to support a fairly tight link between increases in the
IOER rate and increases in short-term market interest rates.”
There was also discussion of longer-range monetary operating
procedures.
Among those who talked about their preferences about the longer-run
framework for monetary policy implementation, the minutes say most
“preferred that monetary policy eventually operate through a corridor
type system in which the federal funds rate trades in the middle of a
range, with the IOER rate as the floor and the discount rate as the
ceiling of the range, as opposed to a floor-type system in which a
relatively high level of reserve balances keeps the federal funds rate
near the IOER rate.”
“A couple of participants noted that any normalization strategy
would likely involve an elevated balance sheet with the federal funds
rate target near the IOER rate — as in floor-type systems — for some
time, and therefore the Committee would accumulate experience during the
process of normalizing policy that would allow it to make a more
informed choice regarding the longer-term framework at a later date,”
the minutes add.
The FOMC made no final decisions about how to proceed and “agreed
that more discussion of these issues was needed.”
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