The January 2019 Fed Minutes

Attention has turned to what extra gems of information might be contained in the release of the FOMC’s January 2019 minutes about the future path of policy. Comments have focused on the Fed’s balance sheet, the consequences of its runoff for financial markets, and what the Fed’s policies might be going forward in terms of balance sheet size and rollover.

Federal Reserve - FOMC

Financial markets have inferred that the runoff of the Fed’s balance sheet has negatively impacted risk-taking incentives, but that inference is largely mistaken and misses the forest for the trees. Indeed, the minutes state that “Participants noted that the ongoing reduction in the Federal Reserve’s asset holdings had proceeded smoothly for more than a year, with no significant effects on financial markets.”

The early portion of the minutes focused on how to better communicate what the FOMC’s intentions are with regard to the size of its balance sheet. The Committee suggested that it will pursue a multipart process to communicate how it will proceed. The first step was a “Statement Regarding Monetary Policy Implementation” in which it revised previous guidance. The statement made two points. First, it indicated that going forward, the Committee will continue to operate its floor system (without calling it such) of administered rates, which will require an ample supply of excess reserves. The Committee will not be returning to the pre-crisis process of affecting rates by managing the scarce supply of reserves. What this says is that the Fed will now go forward with a larger balance sheet – a path determined by the amount of currency in circulation, reserve deposits held by governmental and foreign entities, and a larger cushion (as yet unspecified) of bank reserves. That is, the Desk will set interest rates directly rather than indirectly controlling rates by manipulating the outstanding supply of reserves. The second part of the statement indicates that that the Committee stands ready to adjust its path to normalization depending upon economic and financial developments (read: incoming data).

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