Participants noted that maintaining the current target range for the federal funds rate for a time posed few risks at this point. The current level of the federal funds rate was at the lower end of the range of estimates of the neutral policy rate. Moreover, inﬂation pressures were muted, and asset valuations were less stretched than they had been a few months earlier. Many participants suggested that it was not yet clear what adjustments to the target range for the federal funds rate may be appropriate later this year; several of these participants argued that rate increases might prove necessary only if inﬂation outcomes were higher than in their baseline outlook. Several other participants indicated that, if the economy evolved as they expected, they would view it as appropriate to raise the target range for the federal funds rate later this year.
The staﬀ noted that the Committee had previously indicated that, in the longer run, it intends to operate with no more securities holdings than necessary to implement monetary policy eﬃciently and eﬀectively. In considering the eﬀectiveness of the operating regime, the staﬀ observed that over recent years, the Federal Reserve had been able to implement monetary policy in an environment with ample reserves by adjusting administered rates–including the rates on required and excess reserve balances and the oﬀered rate at the overnight reverse repurchase agreement facility–without needing to actively manage the supply of reserves. Over this period, the eﬀective federal funds rate was generally steady at levels well within the Committee’s target range despite substantial changes in the level of reserves in the banking system and signiﬁcant changes in money markets, regulations, and ﬁnancial institutions’ business models. In addition, other money market rates generally moved closely with the federal funds rate. The current regime was therefore eﬀective both in providing control of the policy rate and in ensuring transmission of the policy stance to other rates and broader ﬁnancial markets.
The aggregate level of reserves had already declined by $1.2 trillion from a peak level of $2.8 trillion reached in October 2014; the decline stemmed from both reductions in asset holdings and increases in nonreserve liabilities such as Federal Reserve notes in circulation. Some recent survey information and other evidence suggested that reserves might begin to approach an eﬃcient level later this year. Against this backdrop, the staﬀ presented options for substantially slowing the decline in reserves by ending the reduction in asset holdings at some point over the latter half of this year and thereafter holding the size of the SOMA portfolio roughly constant for a time so that the average level of reserves would fall at a very gradual pace reﬂecting the trend growth in other Federal Reserve liabilities.
The staﬀ also described options for communicating plans both for the operating regime and for the completion of the normalization of the size of the balance sheet. If the Committee reached a decision to continue using its current operating regime, announcing this decision after the current meeting would help reduce uncertainty about both the long-run implementation framework and the likely evolution of the balance sheet. In addition, the Committee could revise its previous communications to make clear that it was ﬂexible in its approach to normalizing the balance sheet and was prepared to change the details of its balance sheet normalization plans in light of economic and ﬁnancial developments if necessary to support the FOMC’s broader policy goals. The staﬀ noted that, after the end of asset redemptions, the Desk could reinvest principal payments received from holdings of agency MBS in Treasury securities as directed.
Participants noted some of the key advantages of the Federal Reserve’s current operating regime, including good control of the policy rate in a variety of conditions and good transmission to other money market rates and broader ﬁnancial markets. They observed that a regime that controlled the policy rate through active management of the supply of reserves likely would have disadvantages. In particular, the level and variability of reserve demand and supply were likely to be much larger than in the period before the crisis, and stabilizing the policy rate in this environment would require large and frequent open market operations.
Participants judged that, in light of their extensive previous discussions, it was now appropriate to provide the public with more certainty that the Federal Reserve would continue to use its current operating regime.
Participants discussed market commentary that suggested that the process of balance sheet normalization might be inﬂuencing ﬁnancial markets. Participants noted that the ongoing reduction in the Federal Reserve’s asset holdings had proceeded smoothly for more than a year, with no signiﬁcant eﬀects on ﬁnancial markets. The gradual reduction in securities holdings had been announced well in advance and, as intended, was proceeding largely in the background, with the federal funds rate remaining the Committee’s primary tool for adjusting the stance of policy. Nonetheless, some investors might have interpreted previous communications as indicating that a very high threshold would have to be met before the Committee would be willing to adjust its balance sheet normalization plans. Participants observed that, although the target range for the federal funds rate was the Committee’s primary means of adjusting the stance of policy, the balance sheet normalization process should proceed in a way that supports the achievement of the Federal Reserve’s dual- mandate goals of maximum employment and stable prices. Consistent with this principle, participants agreed that it was important to be ﬂexible in managing the process of balance sheet normalization, and that it would be appropriate to adjust the details of balance sheet normalization plans in light of economic and ﬁnancial developments if necessary to achieve the Committee’s macroeconomic objectives.
Almost all participants thought that it would be desirable to announce before too long a plan to stop reducing the Federal Reserve’s asset holdings later this year. Such an announcement would provide more certainty about the process for completing the normalization of the size of the Federal Reserve’s balance sheet. A substantial majority expected that when asset redemptions ended, the level of reserves would likely be somewhat larger than necessary for eﬃcient and eﬀective implementation of monetary policy; if so, many suggested that some further very gradual decline in the average level of reserves, reﬂecting the trend growth of other liabilities such as Federal Reserve notes in circulation, could be appropriate. In these participants’ view, this process would allow the Federal Reserve to arrive slowly at an eﬃcient level of reserves while maintaining good control of short-term interest rates without needing to engage in more frequent open market operations. A few participants judged that there would be little beneﬁt to allowing reserves to continue to fall after the end of redemptions or that this approach could have costs, such as an undue risk of volatility in short-term interest rates, that would exceed its beneﬁts. These participants thought that upon ending asset redemptions, the Federal Reserve should begin adding to its assets to oﬀset growth in nonreserve liabilities, so as to keep the average level of reserves relatively stable. A couple of participants suggested that a ceiling facility to mitigate temporary unexpected pressures in reserve markets could play a useful role in supporting policy implementation at lower levels of reserves.
Participants commented that, in light of the Committee’s longstanding plan to hold primarily Treasury securities in the long run, it would be appropriate once asset redemptions end to reinvest most, if not all, principal payments received from agency MBS in Treasury securities. Some thought that continuing to reinvest agency MBS principal payments in excess of $20 billion per month in agency MBS, as under the current balance sheet normalization plan, would simplify communications or provide a helpful backstop against scenarios in which large declines in long-term interest rates caused agency MBS prepayment speeds to increase sharply. However, some others judged that retaining the cap on agency MBS redemptions was unnecessary at this stage in the normalization process. These participants noted considerations in support of this view, including that principal payments were unlikely to reach the $20 billion level after 2019, that the cap could slightly slow the return to a portfolio of primarily Treasury securities, or that the Committee would have the ﬂexibility to adjust the details of its balance sheet normalization plans in light of economic and ﬁnancial developments. Participants commented that it would be important over time to develop and communicate plans for reinvesting agency MBS principal payments, and they expected to continue their discussion of balance sheet normalization and related issues at upcoming meetings.