How will the Federal Reserve normalize monetary policy when it becomes appropriate to do so?

how does the federal reserve implement monetary policy

During its recent meetings, the Federal Open Market committee (FOMC) discussed ways to normalize the stance of monetary policy. These discussions were part of prudent planning and do not imply that normalization will necessarily begin soon.

At the September 16-17, 2014, meeting, all FOMC participants but one agreed on the following key elements of the approach that they intend to implement when it becomes appropriate to begin normalizing the stance of monetary policy.

  • When economic conditions and the economic outlook warrant a less accommodative monetary policy, the Committee will raise its target range for the federal funds rate.
  • The Committee plans to continue to use the federal funds rate as its key policy rate during the normalization process and to continue to set a target range for the funds rate when it begins to remove policy accommodation and for some time thereafter.
  • During normalization, the Federal Reserve intends to move the federal funds rate into the target range set by the FOMC primarily by adjusting the interest rate it pays to depository institutions on excess reserve balances (IOER).
  • During normalization, the Federal Reserve intends to use an overnight reverse repurchase agreement (ON RRP) facility and other supplementary tools as needed to help control the federal funds rate. The Committee will use the overnight reverse repurchase agreement facility only to the extent necessary to facilitate normalization and will phase it out when it is no longer needed to help control the federal funds rate.
  • The Committee intends to reduce the Federal Reserve's securities holdings in a gradual and predictable manner primarily by ceasing to reinvest repayments of principal on securities held in the System Open Market

    Account (SOMA).

  • The Committee expects to cease or commence phasing out reinvestments after it begins increasing the target range for the federal funds rate; the timing will depend on how economic and financial conditions and the economic outlook evolve.
  • The Committee currently does not anticipate selling agency mortgage-backed securities as part of the normalization process, although limited sales might be warranted in the longer run to reduce or eliminate residual holdings. The timing and pace of any sales would be communicated to the public in advance.

At the FOMC meeting on March 17-18, 2015, all participants agreed to provide the following additional details regarding the operational approach the FOMC intends to use when it becomes appropriate to begin normalizing the stance of monetary policy. When economic conditions warrant the commencement of policy firming, the Federal Reserve intends to:

  • Continue to target a range for the federal funds rate that is 25 basis points wide.
  • Set the IOER rate equal to the top of the target range for the federal funds rate and set the offering rate associated with an ON RRP facility equal to the bottom of the target range for the federal funds rate.
  • Allow aggregate capacity of the ON RRP facility to be temporarily elevated to support policy implementation; adjust the IOER rate and the parameters of the ON RRP facility, and use other tools such as term operations, as necessary for appropriate monetary control, based on policymakers’ assessments of the efficacy and costs of their tools. The Committee expects that it will be appropriate to reduce the capacity of the facility fairly soon after it commences policy firming.

Source: www.federalreserve.gov

Category: Bank

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