Unwinding the Federal Reserve’s balance sheet should start “sooner rather than later,” Federal Reserve Bank of Kansas City President Esther George said Wednesday.
“I support the FOMC’s approach to balance sheet normalization and favor initiating the process in the near future, although I would have preferred to be starting the process with a smaller balance sheet than exists today,” George said at a Denver economic forum, according to prepared text released by the Fed.
Monetary policy remains accommodative despite the four Fed rate hikes, she noted. But, “[m]aking adjustments to the Fed’s sizeable balance sheet is a necessary but unfamiliar part of the [Federal Open Market Committee’s] policy process.”
The Fed has indicated how it plans to accomplish balance sheet normalization, but, George noted, the exact “when” it starts (although the Fed expects it to be later this year) and the “how much” it is reduced “remain to be determined.”
“One reason I favor shrinking the balance sheet sooner rather than later is the observed disconnect between short-term rates and long-term rates,” she said. “Despite four 25-basis-point increases in the target funds rate since December of 2015, longer-term yields remain little changed.”
The FOMC’s Summary of Economic Projections median forecast suggests one more 25-basis-point fed funds rate hike this year and three next year. “If further increases in the target funds rate fail to transmit to longer-term yields, the yield curve could flatten further,” George noted. “Such a rate environment can distort investment decisions. To the extent that reducing our asset holdings will apply some modest upward pressure to longer-term interest rates, balance sheet normalization could promote the more typical transmission of short-term interest rate changes throughout the yield curve and ensure that all components of policy accommodation are removed in a gradual manner.”
As for the amount of decrease, the Fed said it plans to “appreciably” lower the balance sheet total, although it will remain above pre-financial crisis levels.
George opposed continuation of large scale asset purchases (LSAPs) as an FOMC voter in 2013. “In my view, the possible unintended side effects of the ongoing asset purchases posed risks to economic and financial stability and served to unnecessarily further complicate future monetary policy,” she said. “I remain reluctant to advocate for the use of LSAPs in the future outside extraordinary circumstances.”