Federal Reserve Minutes: Balance Sheet Reduction Linked to Planned Interest Rate Increases

The Federal Reserve’s March policy meeting offered some new insight into the central bank’s plans for the remainder of the year. While the Federal Reserve has long telegraphed its intention to increase interest rates as it closes in on its inflation goal of 2 percent, the minutes from the most recent policy meeting show that the Fed also intends to reduce its balance sheet as a consequence of rising interest rates.

This revelation is certainly of interest for many reasons, but the level of disagreement among committee members is also worthy of deeper exploration. The committee, which is comprised of 17 total members and 10 voting members, appeared somewhat divided with regard to the timing of the planned interest rate increases and the subsequent reduction in the balance sheet.

As the minutes indicate, the voting members preferred a more measured approach — and relied on their status as voting members to assert this preference — while many of the non-voting members expressed at least some level of dissent, preferring more immediate action given the potential for headline inflation to cross the previously outlined threshold of 2 percent. After raising their concerns over the potential of exceeding a 2 percent rate of inflation in relatively short order, the prevailing members cited the limited risk associated with increased inflation, largely due to current expectations among consumers and businesses.

Overall, the Federal Reserve expressed optimism for the long-term prospects of the economy. In doing so, however, officials also noted the possibility that the first-quarter GDP reading will fall short of expectations despite the overall health of the economy and the likelihood of substantial growth over the long term. Officials also engaged in a bit of hedging as well, indicating the possibility that an unexpected or otherwise sudden uptick in economic activity could accelerate their current plans for increasing interest rates and reducing the balance sheet.

Addressing the balance sheet, whatever the timing ends up being, will require a reduction in the $4.5 trillion worth of government- and mortgage-backed bonds. As for the actual timing of the balance sheet reduction, the minutes from the policy meeting indicate that officials are currently eyeing a December announcement, which would follow two separate increases in interest rates. In the meantime, it seems quite likely to expect a slowdown in reinvestment as the year continues to progress.

All of this, of course, is subject to change over the coming months. Despite the plan outlined during the policy meeting minutes, the Federal Reserve will surely allow the performance of the economy to dictate the ideal timing for raising interest rates, reducing the balance sheet, and slowing reinvestment.

 

References:

http://www.marketwatch.com/story/fed-plans-to-reduce-its-45-trillion-balance-sheet-this-year-minutes-show-2017-04-05?siteid=bnbh

http://www.cnbc.com/2017/03/15/fed-raises-rates-at-march-meeting.html

http://www.reuters.com/article/us-usa-fed-analysis-idUSKBN16E2S2

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