As I see it, a few questions about this program remain and are worth addressing. The first question is why do this at all. After all, the Fed has had a large balance sheet for many years now. In my view, the balance sheet expansion was undertaken in response to an extraordinary set of circumstances—a deep recession, short-term interest rates at the zero lower bound, and the economy far away from our dual mandate objectives. Now that these circumstances no longer hold, it seems appropriate to begin to reduce the size of the Fed’s balance sheet. In thinking about the decision to reduce the size of the Fed’s balance sheet, I see two important, opposing factors. One is that a large balance sheet could conceivably make further asset purchases less attractive. This factor suggests that we should use the opportunity to shrink the balance sheet during good economic times so that this tool will be fully available to us in the 4/6  BIS central bankers' speeches  future if necessary. However, on the other side, reducing the size of the balance sheet is another form of monetary tightening, one with which we have little experience. This suggests we should proceed with caution. The FOMC has judged that a gradual, predictable approach to normalization is the best way to appropriately balance these two factors. Another question is how long the normalization process will take.
This judgment is supported by the fact that financial conditions have eased, rather than tightened, even as the Fed has raised its short-term interest rate target range by 75 basis points since last December. For example, equity prices have risen, credit spreads have narrowed modestly, longer-term interest rates have declined, and the dollar has weakened. On balance, these movements have been large relative to the upward drift in short-term interest rates. The easing in financial conditions is important because monetary policy does not directly influence the trajectory of economic growth and inflation. Instead, as I have noted in previous remarks, shortterm interest rate changes are an important factor that affects broad financial market conditions.2 Financial conditions, in turn, influence the demand for goods and services by households and businesses. But, if financial conditions ease even as we are removing monetary policy accommodation, this may have implications for further policy adjustments. All else equal, an easing of financial conditions may warrant a somewhat steeper policy rate path. Conversely, if financial conditions were to tighten unduly, then this might necessitate a shallower rate path to temper that tightening. To be clear, this does not mean that the Fed should mechanically target a particular set of financial conditions. That is because the set of financial conditions appropriate to achieving the Fed’s statutory objectives of maximum employment and price stability will evolve over time as the economic outlook changes. Financial conditions are just a means to an end—the achievement of the Fed’s employment and inflation objectives.