Central Bankers and Balance Sheets
Julie Remache, Senior Vice President and Policy Advisor, and Antoine Martin, Senior Vice President and Head of Money & Payments Studies
Earlier this month at the New York Fed, we co-hosted a conference with Trish Mosser of Columbia’s School of International and Public Affairs on normalizing central banks’ balance sheets. This was the second workshop we’ve done, and we had current and former central bankers, academics, market participants, and the press in attendance. While last year we focused on what had been learned about implementing monetary policy following the crisis, this year we focused on what the “new normal” might be for central banks’ balance sheets. For those interested in learning more about what was discussed, the presentations from the event are now available on our website.
The conference was an opportunity to consider the role of central bank balance sheets in the monetary policy implementation framework. With nominal interest rates in many developed countries compressed near historically low levels in the years since the global financial crisis, central banks around the world have been forced to expand the set of tools and operations used to achieve their monetary policy objectives. Central banks have adopted a variety of approaches, but one common feature of their unconventional policies is a large expansion of their balance sheets.
As the outlook for the global economy improves, central banks will begin the process of tightening policy. To that end, we set out to tackle a number of questions during the conference: When should central bank balance sheets be unwound? What are the intended financial market effects of these changes, and what are potential unintended consequences? How will the monetary policy transmission mechanism work as these policies are unwound? What would be a desired composition of the central bank balance sheet over the medium term or longer? What are the tactical considerations in the approach, including the implications for the speed and composition of reducing balance sheets? What should be communicated about how these policies will evolve? Looking globally, what are the international spillovers? How might global funding markets be affected by the reversal of unconventional policies?
In the United States, this is a topic that is particularly relevant, given that the Federal Open Market Committee (FOMC) recently provided more information about the approach it intends to use to reduce the size of the Federal Reserve’s balance sheet, which it has said it plans to do in a gradual and predictable manner. While the FOMC has indicated how the process of balance sheet normalization will begin, there are many important questions remaining about where we are headed: What will be the long-run size of our balance sheet? What kind of assets should we maintain on our balance sheet going forward? What will be the maturity distribution of assets that we hold? And finally, under what circumstances should the balance sheet be used as an active tool for policy implementation?
To provide more information to the public regarding the Fed’s balance sheet, and in advance of the conference, we published an updated set of projections for the Fed’s portfolio of domestic securities — held in the System Open Market Account (SOMA) at the New York Fed. These updated projections build on those published in the SOMA annual report, which also includes extensive information on domestic market operations overall. For convenience, we’ve collected these materials here:
Report: Updated SOMA Portfolio and Income Projections (July 2017) — This report contains projections that update those published in the 2016 SOMA Annual Report (see below). To do so, New York Fed staff revised the projections based on the guidance released by the FOMC in June and on market expectations for interest rates and the size and composition of the Federal Reserve’s balance sheet based on surveys conducted ahead of the June FOMC meeting. These market expectations are drawn from our Survey of Primary Dealers and Survey of Market Participants, which are conducted before every FOMC meeting.
These projections show:
· How the FOMC’s program of gradually increasing runoff caps would apply to the treatment of principal payments on Treasury and agency mortgage-backed securities (MBS).
· The length of time it will take the balance sheet to reach its normalized size based on three different scenarios — though that size will depend on longer-term interest rate developments and the long-run level of Federal Reserve liabilities.
· Even after the balance sheet reaches a normalized size, the portfolio will still contain holdings of agency MBS securities.
· That portfolio net income is projected to be roughly similar to previous projections.
Data File: Updated SOMA Portfolio and Income Projections (July 2017) — Some people just want the raw data, and if you are among them, this file might be useful. For the charts outlined in the updated projects report (see above), we provide all the underlying data so that the public can dig into it. For those interested, this file provides a wealth of information.
2016 SOMA Annual Report (April 2017) — This is our annual report on domestic open market operations from the previous year. This report is released in the spring every year and contains far more information than just projections for the SOMA portfolio and net income. The data file for this report and the archives of past years are available on our website.
In addition, we recently published a set of blog posts that discuss how the Fed can change the size of its outright holdings. These pieces describe the mechanics of balance sheet growth and decline and include:
“How the Fed Changes the Size of its Balance Sheet” — This post on our Liberty Street Economics blog examines the effect that Fed asset purchases have on the stylized balance sheets of various actors in the financial system (such as the Fed, Treasury, banking sector, or nonbank public). In the post, we walk through how we purchase Treasury securities — like we did during and after the financial crisis, which resulted in balance sheet growth — and how we redeem or reinvest them.
“How the Fed Changes the Size of its Balance Sheet: The Case of Mortgage Backed Securities” — Much like the post above, this blog discusses the mechanics of balance sheet growth, but focuses on agency MBS. Purchases and paydowns of MBS involve some different actors than Treasury securities, such as the Government Sponsored Entities (GSEs). While Treasury securities “mature” on a fixed date, agency MBS payments are less predictable, reflecting the option of the borrower to repay the loan early when selling a home or refinancing a mortgage loan. This post covers how the balance sheet size changes, with and without reinvestment of the principal of those paydowns.
As talk of central banks’ balance sheets continue — which it certainly will in the United States given news from the FOMC — it’s important to understand and explore the many issues that may influence choices about central bank balance sheets in the future. We hope participants in the conference earlier this month enjoyed the discussion, and that those who are interested will read the information above.