Fed's Rosengren Calls for Trimming Balance Sheet Soon but Slowly

  • Boston Fed chief says asset purchases likely needed again
  • Fed funds rate should remain ‘primary’ tool for central bank

What Beige Book Report Means for Future of Fed Policy

Federal Reserve Bank of Boston President Eric Rosengren said the central bank should shrink its out-sized balance sheet slowly enough that officials don’t need to alter the path of interest-rate increases.

“The exit from a large balance sheet should be conducted in ways that maintain the primacy of using short-term interest rates to either slow down or stimulate the economy,” Rosengren said in the text of a speech he’s set to deliver Wednesday in Annondale-on-Hudson, New York.

While that exit “could begin relatively soon,” he said, “the tightening of short-term interest rates should not need to be much different than it would be in the absence of shrinking the balance sheet.”

The policy-making Federal Open Market Committee signaled in March it may begin trimming the central bank’s $4.5 trillion balance sheet later this year. Reducing the Fed’s portfolio of bond holdings, like raising interest rates, will increase borrowing costs for companies and households. Officials are so far undecided over how quickly they’ll decrease the balance sheet’s size or how they’ll coordinate the reduction with interest-rate increases.

Current projections from FOMC members suggest the Fed will raise rates by a quarter percentage point twice more this year and three times in 2018, if the economy improves as expected. The FOMC also increased rates in March.

Rosengren, who doesn’t vote this year on the FOMC, said the Fed’s strategy for reducing the balance sheet, if successful, may serve as a “playbook” the central bank could use again as needed. That’s because the persistence of low-growth, low-inflation conditions means interest rates will likely hit zero again in future recessions, forcing the Fed and other central banks to return to asset purchases.

“Low inflation and low growth in both the working-age population and in productivity seem likely for many developed economies in the future,” he said at a conference hosted by Bard College. “Balance sheet expansions -– and exits -– are likely to become more standard monetary policy tools around the world.”

The Fed enlarged its balance sheet to about $4.5 trillion through three rounds of emergency asset purchases to protect the economy during the 2008-2009 financial crisis and the period of weak growth that followed. By purchasing Treasuries and mortgage-backed securities, the Fed aimed to stimulate hiring and spending by pushing down longer-term borrowing rates.

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