This operating framework changed as the financial crisis deepened. By December 2008, the FOMC had lowered its target for the federal funds rate from a point target of 5¼ percent in mid-2007 to a target range of zero to ¼ percent. With the federal funds rate and other shortterm interest rates effectively at the zero lower bound, the FOMC’s operating objective for OMOs was expanded to include adjustments in the size and composition of the Federal Reserve’s securities portfolio. In particular, the FOMC initiated large-scale asset purchases (LSAPs) of agency mortgage-backed securities (MBS), agency debt, and later longer-term Treasury securities, in order to put downward pressure on longer-term interest rates, support mortgage markets, and help make broader financial conditions more accommodative. The expansion of the domestic securities portfolio that resulted from LSAPs vastly increased the supply of reserve balances in the system (Figure 1). 4 Importantly, in October 2008, the Fed was granted authority to pay interest on depository institutions’ reserve balances. 5 In an environment of elevated reserve balances that resulted from the Fed’s asset purchases, the payment of interest on excess reserves (IOER) – currently at a rate of ¼ percent – has kept the overnight federal funds rate within its target range (Figure 2).
I will then discuss the implications of these changes for the Federal Reserve’s balance sheet and for the eventual “normalization” of monetary policy when the Federal Open Market Committee (FOMC) believes it is appropriate to remove the extraordinary levels of monetary policy accommodation that it has provided. Finally, I will discuss some of the considerations that must be taken into account in normalizing monetary policy. As always, these are my views and do not necessarily reflect those of the New York Fed or the Federal Reserve System. The desk’s role in implementing monetary policy The Federal Reserve (the Fed) has a somewhat more complex organizational and governance structure than most other central banks around the world, so before discussing recent developments in the implementation of monetary policy, I’d like to take a moment to describe roles and responsibilities within the Federal Reserve System and where the Desk fits in. The statutory basis for U.S. monetary policy is found in the Federal Reserve Act, which was enacted just over 100 years ago.