The Federal Reserve hopes it will never again have to resort to the unprecedented monetary stimulus efforts it took following the great financial crisis.
In other words, buh-bye QE in the future.
“We would hope that was a very unusual intervention and one that we would not frequently be relying on in the future,” Federal Reserve Chairwoman Janet Yellen said Tuesday, speaking before the Senate Banking Committee in her semi-annual report to Congress. “We do not want to use fluctuations in our balance sheet as an active tool of monetary policy management."
In the aftermath of the 2007 financial crisis, the Fed embarked on a bond-buying spree, purchasing long-term Treasuries and mortgage-backed securities in an effort to stimulate the U.S. economy by putting downward pressure on long-term interest rates.
The policy, known as quantitative easing, ended in 2014, but has left the central bank holding a massive $4.5 trillion portfolio. While the Fed isn’t actively increasing the portfolio, it holds it steady by continuing to roll over maturing Treasuries and reinvest principal payments from the mortgage-backed securities.
That large balance sheet continues to have an “accommodative” effect on financial conditions, Yellen said, even as the Fed has used its more traditional policy tool—the discount rate—to tighten monetary policy twice over the past two years.
Republican senators questioned her about the Fed’s intentions to gradually unwind the balance sheet. Two options include gradually diminishing the reinvestments in the portfolio or stopping them altogether.
Yellen stressed that she wants to hold off on that wind-down effort until the central bank is confident it has enough bandwidth to respond to economic shocks with its more plain-vanilla monetary policy tool, the discount rate. She described it as the “traditional tool” markets best understand and “one we have the most confidence in” to calibrate it relative to the needs of the economy.
“Before we turn that process on and start it, we want to make sure we have adequate ability through our normal interest rate moves to meet the needs of the economy,” she said.
Yellen stressed that her intent is for the Fed’s portfolio to eventually shrink the balance sheet to a level that is “substantially smaller than at the current time,” consisting primarily of U.S. Treasury securities.
The Federal Reserve’s policy making committee next meets in March.