Questions and Answers
Why did the FOMC decide to slow the pace of balance sheet runoff in May 2024?
How does the statement "Plans for Reducing the Size of the Federal Reserve's Balance Sheet" differ in the plans it lays out from the approach the FOMC implemented to reduce the size of its balance sheet over the 2017-2019 period?
Why did the Federal Open Market Committee (FOMC) issue a new statement regarding its principles for reducing the size of the Federal Reserve's balance sheet at its meeting in January 2022?
How does the statement regarding "Principles for Reducing the Size of the Federal Reserve's Balance Sheet" differ from the FOMC's post-meeting statement?
What is the Federal Reserve's "Decisions Regarding Monetary Policy Implementation"--the implementation note--and how does it differ from the FOMC's post-meeting statement?
What size of the Federal Reserve's balance sheet and what level of reserve balances does the FOMC expect to be consistent with efficient and effective implementation of monetary policy?
Why does the Federal Reserve continue operating in a monetary policy regime with ample reserves, in which active management of the supply of reserve balances is not required rather than return to the operating regime that was in place prior to the Global Financial Crisis?
How does a reduction in the Federal Reserve's holdings of Treasury securities, agency debt, and agency mortgage-backed securities translate to a reduction in the reserve balances held by banks?
How are the interest rate on reserve balances (IORB), the overnight reverse repurchase agreement (ON RRP) facility, and other policy tools used to move the federal funds rate into the target range set by the FOMC?
Why did the FOMC decide to slow the pace of balance sheet runoff in May 2024?
The Committee described how it would manage balance sheet runoff in the "Plans for Reducing the Size of the Federal Reserve's Balance Sheet" announced in May 2022. Those plans indicated that in order to ensure a smooth transition from abundant to ample reserve balances, the Committee would slow and then stop the decline in the size of the balance sheet when reserve balances were somewhat above the level it judged to be consistent with ample reserves.
Since the beginning of balance sheet runoff in June 2022, the Federal Reserve's total securities holdings have declined roughly $1.5 trillion as of March 2024. Consistent with its Plans, given this sizable decline in the balance sheet, and the prospect of a more rapid decline in reserve balances as future declines in ON RRP take-up become more limited, the Committee decided to take a cautious approach to further runoff. Slower runoff will give the Committee more time to assess market conditions as the balance sheet continues to shrink. It will also allow banks, and short-term funding markets more generally, additional time to adjust to the lower level of reserves, thus reducing the probability that money markets experience undue stress that could require an early end to runoff. The decision to slow the pace of runoff does not mean that the balance sheet will ultimately shrink by less than it would otherwise. Rather, a slower pace of runoff will facilitate ongoing declines in securities holdings consistent with reaching ample reserves.
How does the statement "Plans for Reducing the Size of the Federal Reserve's Balance Sheet" differ in the plans it lays out from the approach the FOMC implemented to reduce the size of its balance sheet over the 2017-2019 period?
Similar to the 2017-2019 period, the Federal Reserve plans to reduce its securities holdings in a predictable manner primarily by adjusting the amounts reinvested of principal payments received from securities held in the System Open Market Account (SOMA). Specifically, such payments will be reinvested to the extent they exceed monthly caps. However, the Committee judged that strong economic conditions and elevated inflation warranted a faster pace of balance sheet runoff than over the 2017-2019 period.
Why did the Federal Open Market Committee (FOMC) issue a new statement regarding its principles for reducing the size of the Federal Reserve's balance sheet at its meeting in January 2022?
The statement "Principles for Reducing the Size of the Federal Reserve's Balance Sheet" is intended to lay out high-level principles regarding its approach to reducing the size of the Federal Reserve's balance sheet including the sequencing for removing policy accommodation with the Committee's balance sheet and interest rate tools, the approach to balance sheet runoff, and the intended longer-run size and composition of portfolio holdings. As such, the publication of these principles in advance of any decisions or actions should enhance the public's understanding of the FOMC's approach to reducing the size of the Federal Reserve's balance sheet and thus the effectiveness of monetary policy during that period.
How does the statement regarding "Principles for Reducing the Size of the Federal Reserve's Balance Sheet" differ from the FOMC's post-meeting statement?
The statement "Principles for Reducing the Size of the Federal Reserve's Balance Sheet" provides the public with high-level information regarding the Committee's approach to reducing the size of the Federal Reserve's balance sheet. It is intended to enhance the public's understanding of this process. The post-meeting statement, in contrast, announces the Committee's monetary policy stance.
What is the Federal Reserve's "Decisions Regarding Monetary Policy Implementation"--the implementation note--and how does it differ from the FOMC's post-meeting statement?
When the Federal Reserve began the policy normalization process in December 2015 by increasing its target for the federal funds rate for the first time since the Global Financial Crisis, it began issuing an implementation note that reports the decisions the Federal Reserve has taken to implement the monetary policy stance announced by the FOMC in its post-meeting statement. This step was intended to help increase public awareness and understanding of the implementation of monetary policy.
The FOMC's post-meeting statement announces the monetary policy stance, while the implementation note provides the operational settings of the Federal Reserve's policy tools and would also discuss any other policy implementation tools the Federal Reserve may decide to use. As such, the implementation note specifies the interest rate paid on reserve balances, the parameters of the Federal Reserve's overnight repo and reverse repo facilities, balance sheet policies as well as the primary credit rate charged on borrowing from the discount window.
When policymakers change the settings of the Federal Reserve's operational tools, a revised implementation note is issued. The implementation notes, together with the Committee's post-meeting statements and other FOMC materials, are available on the FOMC calendar page of the Federal Reserve's web site.
What size of the Federal Reserve's balance sheet and what level of reserve balances does the FOMC expect to be consistent with efficient and effective implementation of monetary policy?
At the December 2021 FOMC meeting, participants noted that the current size of the balance sheet is elevated and will likely remain so for some time after the process of normalizing the balance sheet was under way. Several participants noted that the level of reserves that would ultimately be needed to implement monetary policy effectively is uncertain, because the underlying demand for reserves by banks is time varying. Against this backdrop, careful monitoring of developments in money markets as the level of reserves decreases will be important to help inform the Committee's eventual assessment of the appropriate size of the balance sheet and the level of reserves in the longer run.
Why does the Federal Reserve continue operating in a monetary policy regime with ample reserves, in which active management of the supply of reserve balances is not required rather than return to the operating regime that was in place prior to the Global Financial Crisis?
Prior to the Global Financial Crisis, the Federal Reserve used a system of scarce reserves and actively managed the supply of reserves. However, thereafter, the Federal Reserve has operated with ample reserves, which doesn't require active management of the supply of reserves. The current operating regime for monetary policy has been working very well. In particular, the regime--in which an ample supply of reserve balances and the Federal Reserve's administered rates ensure control over the level of the federal funds rate and other short-term interest rates--is simple to operate, provides good control over short-term interest rates, and is effective in a wide range of economic environments.
How does a reduction in the Federal Reserve's holdings of Treasury securities, agency debt, and agency mortgage-backed securities translate to a reduction in the reserve balances held by banks?
The Federal Reserve's assets always equal its liabilities plus capital; when assets are reduced, some liability items must also fall. Generally speaking, a reduction in the Federal Reserve's assets does not affect its nonreserve liabilities, such as currency in circulation; instead, it typically leads to a reduction in reserve balances held by banks. For a detailed discussion of the accounting of how reductions in Federal Reserve holdings may affect reserve balances see the FEDS paper: How does the Fed adjust its Securities Holdings and Who is Affected? (PDF)
How are the interest rate on reserve balances (IORB), the overnight reverse repurchase agreement (ON RRP) facility, and other policy tools used to move the federal funds rate into the target range set by the FOMC?
The IORB and ON RRP are essential tools to ensure the effective federal funds rate (EFFR) remains in the target range set by the FOMC. By paying IORB to banks and offering ON RRPs to approved counterparties including nonbanks, the Federal Reserve provides safe and liquid investments to the financial system. The availability of these investments limits downward pressure on short-term market rates, including the federal funds rate, as investors are less willing to accept a lower rate elsewhere. Furthermore, when the EFFR moves to the top or bottom of the target range, the Committee can make "technical adjustment" to the IORB rate and the ON RRP offering rate to ensure the EFFR stays within the target range.
At its meeting in July 2021, the FOMC announced the establishment of two standing repurchase agreement (repo) facilities—a domestic standing repo facility (SRF) and a FIMA Repo Facility for foreign and international monetary authorities—as additional policy tools. These tools will serve as backstops in money markets to support the effective implementation of monetary policy and smooth market functioning. By allowing counterparties to obtain funds from the Federal Reserve, these facilities limit upward pressure in overnight interest rates that could potentially push the EFFR above the target range.
For a detailed discussion of how the Federal Reserve implements monetary policy in an ample reserves regime, see the FEDS paper: The Fed's "Ample-Reserves" Approach to Implementing Monetary Policy (PDF)
For more information on the Federal Reserve's administered rates, please refer to the following links:
https://www.federalreserve.gov/monetarypolicy/reserve-balances.htm
https://www.federalreserve.gov/monetarypolicy/overnight-reverse-repurchase-agreements.htm
https://www.federalreserve.gov/monetarypolicy/standing-overnight-repurchase-agreement-facility.htm
https://www.federalreserve.gov/monetarypolicy/fima-repo-facility.htm