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Board of Governors of the Federal Reserve System
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Federal Reserve Board of Governors

Credit and Liquidity Programs and the Balance Sheet

Longer-term issues

In response to the financial crisis, the Federal Reserve created a number of special lending facilities to stabilize the financial system and support economic activity. As market conditions and the economic outlook have improved, almost all of these programs have been terminated. The Federal Reserve also promoted economic recovery through sharp reductions in its target for the federal funds rate and through purchases of securities. At some point as the economic expansion matures, the Federal Reserve will need to normalize the stance of monetary policy and the size and composition of its balance sheet in order to foster its macroeconomic objectives of maximum employment and price stability.

The Federal Reserve's expanded balance sheet has left the banking system holding a very large quantity of reserves. As a consequence, the Federal Reserve has been developing a number of tools to strengthen its control of short-term interest rates, importantly including new tools to reduce the large quantity of reserves held by the banking system.

The authority granted by the Congress for the Federal Reserve to pay interest on reserve balances beginning in October 2008 will be especially important in the process of removing policy accommodation. Increasing the interest rate on reserves should put significant upward pressure on all short-term interest rates, as banks generally will not lend funds at rates significantly below what they can earn by holding reserves at the Federal Reserve Banks.

The Federal Reserve has been developing other new tools to drain large quantities of reserves, including reverse repurchase agreements (reverse repos) and term deposits. Reverse repos are transactions in which the Federal Reserve sells a security to a counterparty with an agreement to repurchase the security at some date in the future. The counterparty's payment to the Federal Reserve has the effect of draining reserves. As a second means of reducing reserves, the Federal Reserve has plans to offer term deposits to depository institutions. Funds in such term deposits would not be available to satisfy reserve requirements or clear payments and, as a result, would not count as reserve balances. Together, reverse repos and the term deposit facility would allow the Federal Reserve to drain substantial volumes of reserves from the banking system.

The tools available to the Federal Reserve will allow it to reduce policy accommodation when doing so becomes appropriate. In the long run, the Federal Reserve anticipates that the size of its balance sheet will return to more normal levels and that its security holdings will be predominantly Treasury securities.

At the June 21-22, 2011, meeting of the Federal Open Market Committee (FOMC), meeting participants discussed general strategies for normalizing the stance and conduct of monetary policy. This discussion was undertaken as part of prudent planning and did not imply that a move toward such normalization would necessarily begin sometime soon. At the conclusion, participants generally agreed on key elements of the strategy that they expect to follow when it becomes appropriate to begin normalizing the stance and conduct of monetary policy. At the June 18-19, 2013, FOMC meeting, meeting participants, in general, reiterated support for the broad normalization principles set out in June 2011. Nonetheless, they also agreed that the details of the eventual process would depend in part on economic and financial developments between now and the time when it becomes appropriate to begin normalizing monetary policy, and that the FOMC would need to provide additional information about its intentions as that time approaches.

At the April 29-30, 2014, meeting of the FOMC, meeting participants discussed issues associated with the eventual normalization of the stance and conduct of monetary policy. As before, the Committee's discussion of this topic was undertaken as part of prudent planning and did not imply that normalization would necessarily begin sometime soon; however, participants generally agreed that starting to consider the options for normalization at this meeting would help the Committee to make decisions about approaches to policy normalization and to communicate its plans to the public well before the first steps in normalizing policy become appropriate.

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Last update: June 19, 2014