Federal Reserve Governor Jerome Powell said the central bank could revise its plan to eventually sell the securities acquired during its large-scale asset purchases, both to avoid causing financial instability and taking losses on its sales.
“We have the flexibility to normalize the balance sheet more slowly,” Powell said in a speech in New York. “For example, a ‘no asset sale’ plan — under which assets would simply run off as they mature — would push out the date of normalization by only a year or so. That approach would also address concerns over potential market disruption.”
Powell responded to a paper from four economists warning that the Fed may lose control of policy because of potential losses from its more-than-$3 trillion balance sheet. The paper’s authors include Frederic Mishkin, a Columbia University economist and former Fed governor who has co-written research with Chairman Ben S. Bernanke, and David Greenlaw, the chief U.S. fixed income economist at Morgan Stanley.
The central bank is currently purchasing $85 billion a month of Treasuries and mortgage-backed securities, following two previous rounds totaling $2.3 trillion, in an effort to lower an unemployment rate stuck near 7.9 percent in January. Once the economy strengthens, the central bank plans to unwind its balance sheet by raising interest rates and selling many of the assets acquired over the past four years.
The Fed earns interest income from its securities and uses that income to cover its expenses and pay interest on excess reserves held in the banking system. Leftover funds are returned to the Treasury. Last year, these remittances total $88.9 billion.
Choosing to hold their assets until they mature “would also smooth remittances” to the Treasury, Powell said at the U.S. Monetary Policy Forum, sponsored by the Initiative on Global Markets at the University of Chicago Booth School of Business.
Powell’s remarks are a departure from the Fed’s current “exit strategy,” adopted in June 2011, which calls for selling assets from the central bank’s more than $3 trillion balance sheet to return its balance sheet to a normal size and composition.
Prior to the financial crisis the Fed did not have large holdings of mortgage backed securities and as of 2007, the balance sheet was under $900 billion.
If interest rates rise, bond values would decline and the central bank’s payments to the Treasury could disappear for years, according to Fed research. This could lead to a situation in which the central bank ends up monetizing deficits, according to Mishkin, Greenlaw and their coauthors.
Powell said that “an extended period of zero remittances could certainly bring the Federal Reserve under criticism from the public and Congress.”
“The question is whether the Federal Reserve would permit inflation and thereby abandon its post in the face of such criticism,” Powell said. “There is no reason to expect that to happen.”
Concerns about a fiscal crisis coinciding with Fed losses are misplaced, he said.
“The argument has a serious timing problem,” Powell said. “The Federal Reserve’s balance sheet likely will be normalized by late this decade, before the federal debt-to-GDP ratio even increases materially from today’s level.”
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