In my view, we best prepare for the unexpected in two ways: we need to be operationally ready to change course when needed, and we need to remain analytically focused so we know when to recommend to policymakers that they do so. For example, the FOMC has made it clear that it stands ready to resume reinvestment if a material deterioration in the economic outlook were to warrant a sizable reduction in the federal funds rate. The FOMC also indicated that it would be prepared to use its full range of tools, including altering the size and composition of its balance sheet, if future economic conditions were to warrant a more accommodative monetary policy than can be achieved solely by reducing the federal funds rate. Also, unexpected operational demands could emerge from technical developments within the Treasury and agency MBS markets. Even though it is shrinking, the Federal Reserve’s portfolio is and will remain large, and market participants will look to the Federal Reserve to lend out on a collateralized basis some of its holdings of Treasuries and MBS from time to time in order to facilitate settlement, as is done by most other large fixed-income investors.13  Conclusion Let me conclude now by reiterating the message of confidence with which I began my remarks.
When homeowners get a new mortgage with a better interest rate, and pay off their 4/7  BIS central bankers' speeches  old higher rate one in the process, existing agency MBS are paid off more quickly, and replaced with greater issuance of newly-minted agency MBS containing the new, lower-rate loans. The benefit of the FOMC’s redemption cap is that it limits the pace at which securities will flow back into private hands under scenarios in which interest rates fall much more than expected. To illustrate this, projections for agency MBS repayments under a scenario of lower interest rates are shown in Panel 3—as you can see, in this low rate scenario, the caps would still be exceeded even when fully phased in. By providing market participants some certainty that the pace of balance sheet decline will be gradual across economic scenarios, this plan should help mitigate the risk of unexpectedly sharp shifts in asset prices, liquidity, or market functioning should markets begin to put greater weight on lower interest rate scenarios. Indeed, by promoting greater confidence in the stability and liquidity of the Treasury and agency MBS markets across economic outcomes, the FOMC’s plan should result in lower risk and liquidity premia on these assets, relative to normalization plans that do not promote such confidence. Being prepared for the unexpected While I am confident that the FOMC’s plan will work well, there’s always the risk that events unfold differently than expected.