Federal Reserve officials are looking to reverse the massive bond-buying programs they launched during the recession later this year, according to notes from their May meeting released Wednesday.
By shrinking the $4.5 trillion balance sheet the Fed built up over the past nine years, the Fed would accelerate its efforts to return to the kind of U.S. monetary policy seen before the financial crisis.
The minutes from the May 2-3 Fed meeting reported that officials generally “expressed a favorable view” of allowing a certain amount of bonds to run off each month, and then letting that limit increase every three months. The officials agreed that the drawdown could begin this year if the economy doesn’t falter and that they would discuss it further at their upcoming meeting in June.
The notes also indicated that Fed officials thought that another rate hike would be warranted “soon,” suggesting that they are prepared to raise the rate target in June.
The idea behind shrinking the Fed’s balance sheet would be to stave off excessive inflation, a threat that has become more realistic as unemployment has fallen to pre-crisis levels.
By ceasing to buy new Treasury securities and mortgage-backed securities, the Fed will reduce demand for those bonds. As a result, interest rates, all else equal, will rise. From the Fed’s point of view, that would lead businesses and households to borrow less to finance new spending, tamping down inflation.
At the same time, the Fed envisions raising short-term interest rates gradually over the next few years toward the same goal. Fed members projected in March that there would be two more quarter-percentage-point rate increases this year, and more in successive years. Currently, the Fed’s target is just below 1 percent.
In effect, the Fed is thinking through how to reverse the steps it took in the wake of the 2008 financial crisis to stimulate the economy. Then, the Fed lowered its interest rate target to zero and expanded its balance sheet to provide credit to failing financial firms. Then, starting in late 2010 under then-chairman Ben Bernanke, the central bank began “quantitative easing,” or buying bonds in large quantities to try to stimulate the moribund economy. That round of bond purchases, now known as QE2, saw the Fed’s balance sheet rise from $2.3 trillion to $2.9 trillion.
In late 2012, fearing that the recovery would peter out, the Fed started an open-ended program of monthly monthly bond purchases that saw the balance sheet balloon to about $4.5 trillion by late 2014, when Chairwoman Janet Yellen ended the bond purchases. Then, however, the Fed decided that it would reinvest the proceeds of maturing bonds into new purchases, keeping its total bond holdings constant.
