And in circumstances when market functioning is unusually strained, as was the case prior to the Fed’s first LSAP program, asset purchases may enhance liquidity through the central bank’s consistent and significant presence in the market. Over the past six years, the FOMC has been flexible in using these tools, adapting as it learned and as individual circumstances changed. In the first two LSAP programs and MEP, for example, the FOMC communicated an expected total size and completion date for each program. However, the third (and current) LSAP program has been outcome-based, with the FOMC announcing only a monthly pace and composition for its purchases and noting that purchases would continue until there is a substantial improvement in the outlook for the labor market in a context of price stability. Other central banks have also used conditional asset purchases effectively. Perhaps the best example is the Outright Monetary Transactions program announced by the European Central Bank (ECB) in September 2012. This program is credited with helping to stabilize euro-area fixed income markets by ruling out certain bad equilibria. This success was achieved without the purchase of a single asset. Another example of conditional asset purchases is the BoJ’s statement of a commitment to continue QEP until inflation registered stably at or above zero. Changes in the Fed’s balance sheet and implications for normalization So where are we now? The current purchase program appears to be nearing its completion.
The Committee also indicated that an overnight reverse repurchase agreement (ON RRP) facility and other supplementary tools will be used, as needed, to help control the level of the federal funds rate. An ON RRP facility will supplement the primary role of IOER in controlling the federal funds rate by providing an alternative safe, overnight asset for money market investors. I will describe the role of the ON RRP facility in more detail in a moment. 11 The Committee expects to gradually return the balance sheet to a more normal size and composition, primarily by ceasing to reinvest repayments of principal. A halt or reduction in reinvestments is expected to occur after the FOMC begins increasing the target range for the federal funds rate. The FOMC does not plan to use asset sales as part of the normalization process, but suggests that limited sales might be warranted in the longer run to reduce or eliminate residual agency MBS holdings. The Federal Reserve will continue to test some of these tools to gather additional information about their efficacy and to enhance their operational readiness prior to liftoff. For the past year, the Desk has been conducting an exercise of ON RRP operations.