Janet Yellen, during her semiannual monetary policy report to the Congress yesterday, has laid out the control strategy to be used in normalizing the monetary policies.
Currently there are two major monetary control strategies in place. The federal fund interest rate, being set close to 0, is saturated to lower bound. The other one is the balance sheet control strategy, which is saturated to the upper bound due to the end of the QE program in the fall last year.
In normalizing the monetary policy, the Fed could choose between raising interest rates, reducing the balance sheet, or a combination of the two. QE is a non-conventional policy, so reducing the balance sheet is non-conventional, symmetrical to increasing the balance sheet. Therefore it is logical for the Fed to rely on interest policy to normalize its stance. “The FOMC intends to adjust the stance of monetary policy during normalization primarily by changing its target range for the federal funds rate and not by actively managing the Federal Reserve’s balance sheet.” Janet Yellen said yesterday in her prepared report. Reducing the balance sheet will be through natural retiring process. “The Committee intends to reduce its securities holdings in a gradual and predictable manner primarily by ceasing to reinvest repayments of principal from securities held by the Federal Reserve.” Doing so will soften the impact of the non-conventional policy.
The Fed is not quite sure yet about the time to start normalization of monetary policy, neither the pace of interest rate change – at typical 25 bps or smaller.
Reference:
[1] Janet Yellen, Semiannual monetary policy report to the Congress before the committee on banking, housing, and Urban affairs, U.S. Senate, Washington, D.C. February 24, 2015.