For release on delivery
12:55 a.m. EDT (1:55 p.m. local time)
May 28, 2024
The Federal Reserve's Balance Sheet as a Monetary Policy Tool:
Past Lessons and Future Considerations
Remarks by
Michelle W. Bowman
Member
Board of Governors of the Federal Reserve System
at the
2024 BOJ-IMES Conference,
hosted by the Institute for Monetary and Economic Studies, Bank of Japan
Tokyo, Japan
May 28, 2024
I would like to thank the Bank of Japan and Governor Ueda for organizing this
year's conference and for the invitation to participate in this afternoon's panel.1 The
topic of "the effects of conventional and unconventional policy instruments" is an
important one given central banks' expanded use of unconventional monetary policy
tools to pursue their mandates over the past decade and a half.
My remarks focus on the use of the central bank balance sheet as a monetary
policy tool. I will first offer some observations regarding the benefits and costs of large-
scale asset purchases (LSAPs) by reflecting on the two episodes of the Federal Reserve's
active use of the balance sheet in U.S. monetary policy following the 2008 financial crisis
and during the COVID-19 pandemic. I will then discuss some considerations regarding
future balance sheet policy as the Federal Open Market Committee (FOMC) seeks to
bring inflation back down to its 2 percent target following the post-pandemic inflation
surge, and as the FOMC continues to reduce the size of the Federal Reserve's balance
sheet.
Lessons Learned from Past Uses of the Federal Reserve's Balance Sheet as a
Monetary Policy Tool
Post-2008 financial crisis balance sheet policy
A key challenge for the FOMC following the 2008 financial crisis was how to
provide additional support to an economy that was experiencing high unemployment and
subdued inflation after the FOMC lowered its primary and conventional monetary policy
tool-the target range for the federal funds rate-to near zero. Given the importance of
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longer-term interest rates for broader asset prices and for investment and consumption
decisions, the FOMC used both forward guidance and LSAPs to help lower longer-term
rates, which had not yet moved to zero. The intent of forward guidance was to lower
longer-term interest rates by shifting expectations of "low-for-long" short-term interest
rates in line with a low-for-long federal funds rate. LSAPs, or quantitative easing (QE),
were intended to reduce longer-term interest rates further by lowering the yields of
specific longer-dated securities being purchased and by reducing more generally the term
premia, the compensation that investors must earn to incentivize investment in a longer-
term bond relative to a short-term bond. LSAPs could also reinforce the FOMC's
forward guidance of low-for-long short-term interest rates. Such reinforcement of low-
for-long forward guidance could be especially powerful if the FOMC communicated that
it would not consider raising the target range for the federal funds rate until it stopped
actively engaging in asset purchases for the purposes of QE.
The Federal Reserve purchased both Treasury securities and agency mortgage-
backed securities (MBS) as part of its QE programs from 2009 to 2014. Figure 1 shows
the evolution of the Federal Reserve balance sheet assets and liabilities from before the
2008 financial crisis to the present. The Fed's Treasury and agency securities holdings
increased from around half a trillion dollars to around $4.25 trillion by the end of the
third round of QE, which ended in 2014. A range of studies indicate that the Fed's asset
purchases were effective in raising the prices of and lowering the yields on the targeted
class of securities.2 Research suggests that these asset purchases also helped lower term
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and risk premia across other asset classes, including corporate securities.3 The impact on
the MBS pricing and credit flow was significant since securities prices in this asset class
were especially impacted during the financial crisis. Financial institutions holding MBS
on their balance sheets, including banks, were also significantly affected.
Some studies have documented that the Fed's agency MBS purchases encouraged
banks to continue to lend as the prices of their on-balance-sheet MBS holdings rose in
response to QE.4 Overall, the evidence indicates that the Fed's LSAPs following the
financial crisis helped support the economic recovery. The progress on the FOMC's dual
mandate of maximum employment and price stability was assisted by the further easing
of financial conditions after the federal funds rate had reached its effective lower bound.5
The post-financial crisis period experience showed that securities purchases in a specific
Effects of Large-Scale Treasury Purchases: Evidence on the Importance of Local Supply," Journal of
Financial Economics, vol. 108 (May), pp. 425-48; and Arvind Krishnamurthy and Annette
VissingJorgensen (2013), "The Ins and Outs of LSAPs," paper presented at "Global Dimensions of
Unconventional Monetary Policy," a symposium sponsored by the Federal Reserve Bank of Kansas City,
held in Jackson Hole, Wyo., August 22,
https://www.kansascityfed.org/Jackson%20Hole/documents/4563/2013Krishnamurthy.pdf.
3
See, for example, Simon Gilchrist and Egon Zakrajsek (2013), "The Impact of the Federal Reserve's
Large-Scale Asset Purchase Programs on Corporate Credit Risk," Journal of Money, Credit and Banking,
vol. 45 (s2), pp. 29-57; and Simon Gilchrist, David Lopez-Salido, and Egon Zakrajsek (2015), "Monetary
Policy and Real Borrowing Costs at the Zero Lower Bound," American Economic Journal:
Macroeconomics, vol. 7 (January), pp. 77-109.
4
See, for example, Alexander Rodnyansky and Olivier M. Darmouni (2017), "The Effects of Quantitative
Easing on Bank Lending Behavior," Review of Financial Studies, vol. (November), pp. 3858-87; Indraneel
Chakraborty, Itay Goldstein, and Andrew MacKinlay (2020), "Monetary Stimulus and Bank Lending,"
Journal of Financial Economics, vol. 136 (April), pp. 189-218; Robert Kurtzman, Stephan Luck, and Tom
Zimmermann (2022), "Did QE Lead Banks to Relax their Lending Standards? Evidence from the Federal
Reserve's LSAPs," Journal of Banking and Finance, vol. 138 (May).
5
See for example Eric Engen, Thomas Laubach, and David Reifschneider (2015), "The Macroeconomic
Effects of the Federal Reserve's Unconventional Monetary Policies," Finance and Economics Discussion
Series 2015-005 (Washington: Board of Governors of the Federal Reserve System, February),
http://dx.doi.org/10.17016/FEDS.2015.005; Kyungmin Kim, Thomas Laubach, and Min Wei (2020),
"Macroeconomic Effects of Large-Scale Asset Purchases: New Evidence," Finance and Economics
Discussion Series 2020-047 (Washington: Board of Governors of the Federal Reserve System, June,
revised August 2023), https://doi.org/10.17016/FEDS.2020.047r1; and Stephan Luck and Tom
Zimmermann (2020), "Employment Effects of Unconventional Monetary Policy: Evidence from QE,"
Journal of Financial Economics, vol. 135 (March), pp. 678-703.
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asset class could be effective for those asset classes that had experienced stress, as was
the case with MBS during that period.
The Federal Reserve concluded its asset purchases in 2014, after initiating the
tapering process in 2013. In 2017, the Fed began to reduce its securities holdings, which
is often referred to as quantitative tightening (QT). In January 2019, the FOMC voted to
operate monetary policy in an "ample reserves" environment.6 This change in the policy
implementation framework had the effect of keeping the size of the balance sheet much
larger and providing more liquidity to the banking system in normal times than had been
the case before the financial crisis. The FOMC ended QT in August 2019, and balance
sheet growth resumed in October 2019 through the purchase of U.S. Treasury bills and
securities following a brief period of stress in money markets in which the interest rates
on repurchase agreements and other short-term funding instruments jumped, as noted by
the line labeled "Repo Spike" in figure 1. This stress was interpreted as an indication that
the level of reserves had fallen below ample levels.7
Overall, one could deem the post-financial crisis use of the Federal Reserve's
balance sheet as a monetary policy tool as a success. Unemployment fell and inflation
remained near 2 percent through the period over which LSAPs were conducted. The
FOMC was able to end LSAPs and eventually was able to partially unwind them, though
the overall terminal size of the Fed's securities holdings as a share of GDP following the
end of QT was much greater than before the financial crisis. This much larger end state
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was a direct result of the FOMC's decision to implement monetary policy in an ample-
reserves operating framework and had the effect of lowering the likelihood of future
volatility in short-term funding markets.8
COVID-19 pandemic balance sheet policy
Given the effectiveness of the balance sheet as a monetary policy tool over the
previous decade, the FOMC rapidly deployed LSAPs in March 2020 as part of its
response to the pandemic.9 These purchases followed the onset of the COVID-19
pandemic at that time, and the FOMC returned the federal funds rate to its effective lower
bound. Following an initial higher level of Treasury and agency MBS purchases
motivated both by restoring market functioning following a period of severe stress and by
providing monetary policy accommodation, the FOMC began to purchase $80 billion of
Treasury securities and $40 billion of agency MBS per month. In its December 2020
post-meeting statement, the FOMC communicated that it intended to continue this pace
of asset purchases "until substantial further progress has been made toward the
Committee's maximum employment and price stability goals."10 By the end of the
pandemic period asset purchases, total securities held by the Federal Reserve stood at
around $8.5 trillion.
8
At the end of balance sheet runoff, the Fed's securities holdings totaled around $3.6 trillion. The FOMC
had considered other types of operating regimes, including those that would result in a lower level of
securities holdings in the longer run. See, for example, the discussion in the November 2018 FOMC
minutes, which can be found on the Board's website at
https://www.federalreserve.gov/monetarypolicy/fomccalendars.htm.
9
The Federal Reserve also implemented 13 emergency lending and liquidity facilities under its emergency
lending authorities and undertook supervisory and regulatory actions to support the flow of credit to
households, businesses, and local governments; see "Funding, Credit, Liquidity, and Loan Facilities" and
"Supervisory and Regulatory Actions in Response to COVID-19" on the Board's website at
https://www.federalreserve.gov/funding-credit-liquidity-and-loan-facilities.htm and
https://www.federalreserve.gov/supervisory-regulatory-action-response-covid-19.htm, respectively.
10
See the December 2020 FOMC statement, which is available on the Board's website at
https://www.federalreserve.gov/monetarypolicy/fomccalendars.htm (quote text in paragraph 4).
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The pace of asset purchases during the pandemic period was much greater than in
the previous QE episodes. Conditions in the economy and financial system were also
different than those that prevailed following the 2008 financial crisis in significant ways.
The stabilizing actions taken by the Federal Reserve to restore market functioning and to
support financial stability in the first half of 2020, in addition to the much higher capital
levels in the banking system relative to 2008, enabled the financial system to remain
resilient. Credit continued to be available to households, businesses, and local
governments following the pandemic's onset.
The U.S. Congress and the Administration also provided extraordinary fiscal
support in response to the pandemic-which included stimulus checks sent to
households, expanded unemployment insurance, and the Paycheck Protection Program-
that bolstered household and business balance sheets.11 The housing market-recently
recovered from the buildup of poorly underwritten mortgage debt in the lead-up to the
2008 financial crisis and a subsequent steep decline in house prices-remained in sound
condition. And as households and families sought larger living spaces and amenities as
they worked from home during the pandemic, house prices increased sharply.
In hindsight, the sharp contrast between the economic and financial system
conditions during the pandemic period and those following the 2008 financial crisis raise
questions about the similarities in the response of the Federal Reserve and FOMC to
these events. Was such a strong balance sheet policy response during the pandemic
appropriate, and to what extent did such a strong balance sheet policy response contribute
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to the buildup of inflationary pressures and the post-pandemic inflation surge? Given the
underlying strength in the housing market, should the FOMC have conducted such large
purchases of agency MBS into late 2021? Given the strong fiscal response to support
spending by households and businesses and large issuance of Treasury debt, should the
FOMC have conducted such large purchases of Treasury securities into late 2021? I look
forward to our conversation today and to future studies on these questions, such as those
conducted regarding the effectiveness of balance sheet policies following the 2008
financial crisis.
My own view is that the FOMC would likely have benefited from an earlier
discussion and decision to begin tapering and subsequently end asset purchases in 2021
given the signs of emerging inflationary pressures.12 Doing so would have allowed the
FOMC the option to have begun to tighten monetary policy earlier by raising the target
range for the federal funds rate. While a robust and rapid response by the FOMC was
appropriate in 2020, I think it is worth asking whether such a robust response for so long
was appropriate. The economic and financial system conditions were very different
during the pandemic and included a strongly accommodative fiscal backdrop.
Could the FOMC have reduced its pace of asset purchases earlier once it was
clear that market turmoil had subsided, just as the 13(3) emergency lending facilities
established in 2020 were allowed to expire and exit plans developed for those programs?
A thorough discussion of these questions will be a useful reference for the FOMC and
other central banks as they consider future use of QE as a monetary policy tool. This
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perspective would be helpful for historical reference when formulating appropriate
balance sheet policy as a monetary policy response to future episodes when the
conventional interest rate tool is near zero.
Another important difference between the FOMC's balance sheet policy
following the pandemic and its balance sheet policy following the 2008 financial crisis
was the speed and timing of the subsequent reduction in the size of the Federal Reserve's
securities holdings during the period of QT.13 This difference reflects the larger amount
of securities purchases compared to the earlier periods of QE as well as the quite different
economic conditions facing the FOMC at the start of QT post-pandemic. These
conditions included too-high inflation and a desire by the FOMC to tighten monetary
policy through both the federal funds rate and the balance sheet tools.
So far, the rapid and sustained pace of the Federal Reserve's securities runoff has
proceeded relatively smoothly. A useful question for further inquiry is to what extent
during the post-pandemic period has QT served to further tighten financial conditions.
With the understanding that QT is a tool employed beyond conventional monetary policy
restriction, how does one measure the incremental increase above the FOMC's
concurrent increases in the target range for the federal funds rate and related forward
guidance regarding its policy rate? Evidence to date suggests that QT exerts an
independent effect on tightening financial conditions, though in some cases it may be
asymmetric to the effects of QE.14 Quantifying the effects of QT as well as QE will be
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helpful to policymakers in their future deliberations regarding use of the balance sheet in
setting monetary policy.
Future Considerations regarding the Federal Reserve's Balance Sheet Policy
Looking ahead, the FOMC continues to reduce the size of its balance sheet as it
seeks to maintain a sufficiently restrictive stance of monetary policy to bring inflation
back down to its 2 percent goal. Recently, the FOMC voted to slow the pace of securities
runoff by around half beginning in June.15 In its Plans for Reducing the Size of the
Federal Reserve's Balance Sheet released in May 2022, the FOMC noted that it would
eventually slow and then stop securities runoff when reserve balances are somewhat
above the levels it judges to be consistent with ample reserves to ensure a smooth
transition to ample-reserves levels.16 Aggregate reserve levels currently stand at around
the levels at the start of balance sheet runoff in June 2022, and there are still sizable
balances in the overnight reverse repurchase agreement (ON RRP) facility. In light of
these conditions, I would have supported either waiting to slow the pace of balance sheet
runoff to a later point in time or implementing a more tapered slowing in the pace of
runoff.17
'Quantitative Tightening Around the Globe: What Have We Learned?' by Wenxin Du, Kristin Forbes and
Matthew Luzzetti," speech delivered at the 2024 U.S. Monetary Policy Forum sponsored by the University
of Chicago Booth School of Business, March 1,
https://www.dallasfed.org/news/speeches/logan/2024/lkl240301.
15
See the May 2024 FOMC statement, which is available on the Board's website at
https://www.federalreserve.gov/monetarypolicy/fomccalendars.htm.
16
See the Plans for Reducing the Size of the Federal Reserve's Balance Sheet, which is available on the
Board's website at https://www.federalreserve.gov/monetarypolicy/policy-normalization.htm.
17
Aggregate reserves stood at around $3.3 trillion just before start of balance sheet runoff in June 2022; see
Board of Governors of the Federal Reserve System (2022), Statistical Release H.4.1, "Factors Affecting
Reserve Balances of Depository Institutions and Condition Statement of Federal Reserve Banks" (June 2),
https://www.federalreserve.gov/releases/h41/20220602.
While it is important to slow the pace of balance sheet runoff as reserves approach
ample levels, in my view we are not yet at that point, especially with still sizable take-up
at the ON RRP.18 In my view, it is important to continue to reduce the size of the balance
sheet to reach ample reserves as soon as possible and while the economy is still strong.
Doing so will allow the Federal Reserve to more effectively and credibly use its balance
sheet to respond to future economic and financial shocks.
As balance sheet runoff proceeds, however, it will eventually be appropriate to
stop runoff as reserves near an ample level. The FOMC will be monitoring money
market conditions and related interest rates as it assesses the point at which reserve levels
reach ample.19 It will be important to communicate that any future changes to balance
sheet runoff do not reflect a change in the FOMC's monetary policy stance. Not
effectively communicating this point might cause the public to interpret the endpoint of
QT as a signal that the FOMC would decrease the target range for the federal funds rate,
thereby causing financial conditions to inappropriately ease.
Another important issue regarding future balance sheet policy is what the
composition of the Federal Reserve's securities holdings should be in the longer run. As
noted in the FOMC's January 2022 Principles for Reducing the Size of the Federal
Reserve's Balance Sheet, the FOMC intends to hold primarily Treasury securities in the
longer run to minimize the effects of the Federal Reserve's holdings on the allocation of
credit across the economy.20 I strongly support this principle. Consistent with this
statement, the FOMC will reinvest any principal payments from agency MBS holdings
above the current runoff cap into Treasury securities. And once balance sheet runoff
concludes, my expectation is that proceeds from agency MBS holdings would continue to
be reinvested in Treasury securities in order to facilitate a transition of the Federal
Reserve's balance sheet holdings to consist of primarily Treasury securities.
The longer-run maturity structure of the Federal Reserve's Treasury securities
holdings is also an important consideration. A benefit of a balance sheet Treasury
security maturity structure that mirrors the broader Treasury market is that the Fed's
holdings would be "neutral" in the sense that they would not disproportionately affect the
pricing of any given maturity of Treasury security or provide incentives for the issuance
of any given type of Treasury security. However, a balance sheet tilted slightly toward
shorter-dated Treasury securities would allow some flexibility in approach. For example,
the FOMC could reduce its holdings of shorter-dated Treasury securities in favor of
longer-dated Treasury securities in a future scenario in which the FOMC wanted to
provide monetary policy accommodation via the balance sheet without expanding the
size of its securities holdings. This approach would be similar to the FOMC's maturity
extension program in 2011 and 2012, sometimes referred to as "operation twist."21 It will
be important to consider such potential costs and benefits to the Federal Reserve's
Treasury securities maturity structure and the best ways to achieve the desired maturity
structure over time.
It is also important for the FOMC to clearly distinguish when the goal of future
asset purchases is restoring market functioning or supporting financial stability. In my
view, when the Federal Reserve purchases securities for such purposes, it should
communicate that those purchases will be temporary and subsequently unwound when
financial market conditions have normalized.22
In conclusion, the FOMC's past experiences with using the Federal Reserve's
balance sheet as a monetary policy tool have demonstrated that the central bank balance
sheet can be an effective way to ease financial conditions and support the economy in
periods in which the conventional monetary policy interest rate tool has reached the zero
lower bound. Importantly, the U.S. experience shows that the effects of QE and QT can
have varying effects depending on the economic and financial system environment, an
important consideration for future episodes.
Just as when using the conventional monetary policy interest rate, monetary
policymakers must use the balance sheet judiciously when setting monetary policy.
Policymakers must also consider the risks of "doing too little" in balance with the risks of
"doing too much" as they pursue their monetary policy mandates.
Thank you, and I look forward to our conversation.
Figure 1: Federal Reserve Assets and Liabilities
Weekly Trillions of dollars
Other assets
QT II
10
Credit and liquidity lacilities
Agency debt & mortgage-backed securities
COVID-19
Treasury securities
response
Repo
QT I
spike
QE II QE III
2008 Financial crisis
response & QE I
9876543210
-1
-2
-3
-4
-5
-6
Currency in circulation
-7
Reserve balances
-8
Reverse repurchase agreements
Capital & other liabilities
-9
-10
2008 2010 2012 2014 2016 2018 2020 2022 2024
Note: "Other assets" includes repurchase agreements, FIMA (Foreign and International Monetary Authorities) repurchase agreements, and unamortized premiums and discounts
on securities held outright. "Credit and liquidity facilities" consists of primary, secondary, and seasonal credit; term auction credit; central bank liquidity swaps; support for Maiden
Lane, Bear Stearns Companies, Inc., and AIG; and other credit and liquidity facilities, including the Primary Dealer Credit Facility, the Asset-Backed Commercial Paper Money
Market Mutual Fund Liquidity Facility, the Commercial Paper Funding Facility, the Term Asset-Backed Securities Loan Facility, the Primary and Secondary Market Corporate
Credit Facilities, the Paycheck Protection Program Liquidity Facility, the Municipal Liquidity Facility, and the Main Street Lending Program. "Agency debt and MBS" holdings
includes agency residential mortgage-backed securities and agency commercial mortgage-backed securities. "Capital and other liabilities" includes the U.S. Treasury General
Account and the U.S. Treasury Supplementary Financing Account. QE is quantitative easing; QE is quantitative tightening. The key identifies shaded areas in order from top to
bottom.The data extend through May 15, 2024.
Source: Federal Reserve Board, H.4.1.