The “big news” from Janet Yellen’s recent press conference, which was hardly news at all to those who have followed the Fed’s past announcements, was that Fed officials, having long promised to eventually undo much if not all of the vast balance sheet growth brought about by the Fed’s various QE operations, and having delayed paying the piper for as long as pressure from without permitted, are finally about to get started.
But don’t imagine that Fed staff have been idle during the long delay. On the contrary: they spent much of it developing their highly scientific balance-sheet reduction strategy, first revealed back in June. As the Fed doesn’t seem to have given that highly scientific plan a name, I hope I may take the liberty of proposing one. Let’s call it “Operation SNAIL.”
In case you haven’t guessed, the acronym stands for “Stall Now And Inch-along Later.” For if there’s any clear point to the strategy the Fed has chosen, it’s to shrink as slowly as possible — more slowly, even, than it would if it merely allowed maturing assets to passively roll-off its balance sheet.
A purely passive unwind would, to be sure, have been problematic, for it would have meant slimming down at a very uneven pace, with bunches of assets rolling off the Fed’s balance sheet during some intervals, and relatively few rolling off in others.
The Fed has chosen to address only the first of these problems, by placing varying limits or “caps” on the value of assets it will allow to roll-off its balance sheet during any particular month. Starting in October with maximum roll-offs of $6 billion in Treasuries and $4 billion in MBS, it plans to increase the caps by those same amounts every three months for a year, after which they’ll remain fixed at $30 billion for Treasury securities and $20 billion for MBS. Whenever the value of maturing assets of either sort exceeds its assigned cap, the Fed plans to reinvest the difference.
Following this plan, it will take until sometime in 2020 for the Fed to slim-down from its current $4.5 trillion in assets to a bit more than $3 trillion, or well over three times its (not exactly svelte) size before the crisis. It’s a diet of sorts, to be sure. But then, so is skipping the cheesecake now and then.
Econbrowser blog post on the subject, James Hamilton illustrates the progress of the Fed’s unwind in several nice charts, including the one reproduced below.Besides showing the slow pace of the unwind, the chart also shows that $3 trillion or so is as low as the Fed is likely to go: by the end of 2020, its balance sheet will start swelling once again.
In comparison, were the Fed committed to getting its balance sheet back on its pre-crisis trajectory by the end of 2020, it would be planning on slimming down by at least another $500 billion, and perhaps by as much as another $1 trillion.
Why So Slow? Why So Little?
Were the Fed’s plan the only way for it to achieve a smooth unwind, its snail-like pace might be justified. But it isn’t: the Fed might easily have provided for a smooth unwind, at a faster pace, by combining higher roll-off caps with occasional active asset sales during low roll-off periods.