However, even if our balance sheet stays large for a while, we have two broad means of tightening monetary policy at the appropriate time – paying interest on reserve balances and taking various actions that reduce the stock of reserves. In principle, we could use either of these approaches alone; however, to ensure effectiveness, we likely would use both in combination.
The Congress granted us authority last fall to pay interest on banks' balances at the Federal Reserve. Currently, we pay banks an interest rate of 1/4 percent. When the time comes to tighten policy, we can raise the rate paid on reserve balances as we increase our target for the federal funds rate.