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.
At last week’s meeting, the FOMC also reaffirmed its view that it likely will be appropriate to maintain the current zero to ¼ percent target range for the federal funds rate for a considerable time after the asset purchase program ends, especially if projected inflation continues to run below the Committee’s 2 percent longer-run goal, and provided that longerterm inflation expectations remain well anchored. Meanwhile, as a matter of prudent planning, the Committee has been deliberating how it should proceed to remove policy accommodation (often called “normalization”), when it believes the appropriate time to do so comes. Although the specific timing of this is not yet known, it’s certain that the level of reserve balances in the banking system will be very high. Assuming no other liabilities are issued, there would be about $ trillion in reserves – mostly in excess reserves – if the Committee ends asset purchases next month and continues reinvestments. In itself, an elevated level of reserve balances need not impede the FOMC’s ability to effectively raise the level of short-term interest rates because of the ability to pay interest on excess reserves. BIS central bankers’ speeches  5  Following last week’s FOMC meeting, the Committee released a revised set of normalization principles and plans (taking into account changes in the SOMA portfolio and enhancements in available tools since it originally issued such principles in June 2011) that it intends to implement when it becomes appropriate to begin normalizing the stance of monetary policy.