WASHINGTON (MNI) – The following is the second and final part of
excerpts from the minutes of the April 26-27 meeting of the Federal Open
Market Committee in which 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. 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. In addition,
changes in the statement language regarding forward policy guidance
would need to accompany the normalization process.

Participants expressed a range of views on some aspects of a
normalization strategy. 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. 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.

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.

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. As a result, the Committee
would later have the option of easing policy with an interest rate cut
if economic conditions then warranted.

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. 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. 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.

Most participants saw changes in the target for the federal funds
rate as the preferred active tool for tightening monetary policy when
appropriate. 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, in part because
doing so 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.

A number of participants also noted that they would be prepared to
sell securities sooner if the temporary reservesdraining 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. In the discussion of
normalization, some participants also noted their preferences about the
longer-run framework for monetary policy implementation.

Most of these participants indicated that they preferred that
monetary policy eventually operate through a corridortype 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 rateas in floor-type systemsfor 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 Committee agreed that more discussion of these issues was
needed, and no decisions regarding the Committee’s strategy for
normalizing policy were made at this meeting.

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** Market News International Washington Bureau: 202-371-2121 **

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