Simon Potter: Implementing monetary policy with the balance sheet Keynote remarks by Mr Simon M Potter, Executive Vice President of the Markets Group of the Federal Reserve Bank of New York, at the ECB Workshop on "Money markets, monetary policy implementation and central bank balance sheets", Frankfurt am Main, 6 November 2017. * * * I would like to thank Deborah Leonard for her assistance in the preparation of these remarks, and colleagues in the Federal Reserve System for numerous insightful comments and suggestions. I’d like to thank the European Central Bank (ECB), both for inviting me to give this keynote address and for organizing this conference on money markets, monetary policy implementation, and central bank balance sheets. I’d also like to congratulate all of the presenters and discussants, whose engaging research and critiques help to foster a deeper understanding of some of the many policy implementation issues central bankers face as we digest past challenges and prepare for future ones. This conference comes as several major central banks reached milestones using their balance sheets as active tools for providing monetary policy accommodation. The ECB just announced it will extend its bond purchasing program but scale back the pace of purchases starting next year. The Bank of England completed purchases under its Gilts and Corporate Bond Purchases schemes and confirmed an upcoming close to the drawdown period for its Term Funding Scheme.
Instead, the FOMC’s approach promotes the use of the federal funds rate as the active monetary policy instrument—an instrument with which it has much greater experience, likely helping to minimize the risk of an error in the early and still-vulnerable stages of the economy’s recovery.40 Running down the balance sheet passively, in a gradual and predictable manner, once normalization of short-term interest rates is well underway puts the balance sheet’s normalization in the background. The stock view of central bank purchase programs holds that given an expected path of the portfolio, the pace of actual changes in the portfolio should have little direct effect on asset prices. Assuming markets anticipate a gradual unwind in the portfolio, asset prices would adjust gradually over time. Nevertheless, central banks may wish to mitigate any possible risk that flow effects associated with overly fast flows of securities into private hands interfere with monetary policy implementation or disrupt market functioning. A conservative feature in the Fed’s approach is therefore a one-year transition period during which gradually rising redemption caps are phased in, thus allowing financial markets and the U.S. Treasury time to adjust to the Fed’s declining market presence. These design features likely enhance overall program effectiveness. However, this outcome is traded off against a more rapid achievement of balance sheet normalization—something some policymakers might hold as a desirable objective. For example, they might see a smaller balance sheet as one that offers greater capacity for using asset purchases more fully again in the future.