Published April 11, 2013
HONG KONG – A top Federal Reserve official on Thursday took an early stab at how the central bank should reduce its swelled balance sheet to a more normal size in the years ahead, arguing the current plan may need some adjusting.
In a detailed speech to a Hong Kong audience, Philadelphia Fed President Charles Plosser urged a return to pre-crisis monetary policy as soon as possible and warned of a possibly quicker-than-previously-envisioned selloff of assets.
The Fed's unprecedented bond-buying stimulus has boosted its balance sheet to some $3.2 trillion in longer-term securities, raising concerns over how it will return to a more normal level of about $1 trillion without disrupting markets or racking up losses later this decade.
Plosser, an outspoken policy hawk and longtime critic of the bond-buying, said the Fed would be wise to begin swapping maturing longer-term assets with shorter-term ones, aiming to hold only Treasury bonds and not the mortgage bonds it is now buying.
The ultimate goal, he said, should be to reduce the balance sheet so that the key "federal funds" interest rate again becomes the central bank's main policy instrument. The federal funds rate has been near zero since late 2008 to help drag the U.S. economy out of recession.
"The complexity of shrinking the balance sheet is nuanced," Plosser, who is often in the minority of Fed opinion and does not have a vote this year on monetary policy, told the Market News International Seminar.
"We are in uncharted territory in this regard and should be appropriately cautious in specifying too detailed a path that we may not be able to follow," he said, according to prepared remarks.
The Fed published its so-called "exit strategy" from the extraordinary policies back in mid-2011; Fed Chairman Ben Bernanke recently said it needs a rethink.
The balance sheet could rise to $4 trillion by year end if the Fed continues buying $85 billion in monthly Treasuries and mortgage-backed securities. While the central bank is transferring large profits to the U.S. Treasury now, it may run into the red if it sells these assets when longer-term rates eventually rise.
At its March policy meeting, Fed policymakers began discussing whether it would be best not to sell the assets and simply let them mature, a decision that could stabilize markets and curb any politically-sensitive losses.
Shedding further light on where this debate may head, Plosser warned that excess bank reserves now total $1.8 trillion and could grow to $2.25 trillion if the ultra easy policies continue apace.
"That may require the Fed to sell assets at a somewhat faster pace than contemplated in the principles adopted in 2011," he said.
"This action would heighten the risk that the Fed would be selling longer-term assets at a loss, which would affect the Fed's remittances to the Treasury," he added. "There might even be negative remittances (losses)."
Getting down into the weeds of monetary policy, Plosser said he didn't want the outsized balance sheet to dissuade the Fed from its traditional "corridor" system in which the federal funds rate floats between a lower rate paid on the bank reserves, and a higher discount rate at which banks can get emergency funds.
He also urged the Fed to increase the discount rate from the current 0.75 percent to "more normal, or non-crisis, levels."
(Reporting by Clement Tan in Hong Kong; Writing by Jonathan Spicer in New York; Editing by Diane Craft)