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Yellen Says Fed to Have Big Balance Sheet for Some Time

Federal Reserve Chair Janet Yellen said policy makers have the necessary tools to raise interest rates at the appropriate time and that the central bank will continue to hold a large balance sheet “for some time.”

Discussions on exiting from record monetary accommodation now under way “are in no way intended to signal any imminent change” in policy, Yellen said at a press conference in Washington following the central bank’s policy meeting.

“The committee is confident it has the tools it needs to raise short-term interest rates” when necessary, she said. The Fed “will continue to have a very large balance sheet for some time.”

The Fed is testing new tools that would allow it to keep a large balance sheet even after it raises short-term interest rates, a step policy makers anticipate taking next year. They would use these tools to drain excess reserves temporarily from the banking system.

Term Deposits

Tools include the Term Deposit Facility, in which the Fed pays banks a premium on their funds in exchange for leaving their money in the facility, and interest on excess reserves, or the amount the Fed pays banks for money deposited at the central bank.

The Fed since September has also experimented with an overnight, fixed-rate reverse-repurchase program to drain cash from the banking system. In a reverse repo, the central bank lends securities for cash for a set period. At maturity, the securities are returned to the Fed, and the cash to primary dealers.

Reinvestment Strategy

Fed officials have been discussing when the Fed will stop reinvesting the proceeds from maturing bonds in its portfolio.

Officials in June 2011 adopted an exit strategy that aimed to return the balance sheet to its pre-crisis size. The strategy called first for allowing the balance sheet to shrink gradually as assets matured. The Fed later would raise the short-term rate and then slowly start to sell assets, focusing on ridding the portfolio of housing debt.

“Broadly speaking, some of the principles that were incorporated in that 2011 package -- the notion that we fully expect our balance sheet to shrink considerably over time” toward levels of “efficient” monetary policy -- “that’s still an expectation,” Yellen said during today’s press conference.

Last June, then-Chairman Ben S. Bernanke said most officials didn’t favor selling the Fed’s portfolio of housing debt, now valued at $1.6 trillion. Instead, the portfolio would be allowed to shrink gradually as the bonds matured.

Mortgage Securities

That continues to be the case, Yellen said: “We would be very unlikely to sell mortgage-backed securities.”

Federal Reserve Bank of New York President William C. Dudley suggested in a May 20 speech that the central bank should continue to reinvest maturing debt even after it raises interest rates.

“Ending reinvestments as an initial step risks inadvertently bringing forward any tightening of financial conditions as this might foreshadow the impending lift-off date for rates in a manner inconsistent with the committee’s intention,” he said.

Kansas City Fed President Esther George, in a June 3 speech, disagreed, saying it was “important” to follow through with “the 2011 principles” unless there was a major change in the outlook. “Central banks should make efforts to follow through on their plans, otherwise they risk losing credibility,” she said.

Economists in a Bloomberg survey prior to this week’s meeting were divided on when the Fed would stop reinvesting.

Forty-nine percent of 57 economists said the Fed would stop reinvesting maturing debt in 2015, while 28 percent said the Fed would stop in 2016. Another 25 percent said the Fed would continue to reinvest for several years.

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