By Michael S. Derby
May 19 (Reuters) – A Federal Reserve Bank of New York official responsible for implementing monetary policy said on Tuesday that the central bank’s current rate control toolkit would still work in a system allowing banks to hold fewer reserves.
New York Fed System Open Market Account Manager Roberto Perli also said the pace of future Treasury bill buying will be determined by market conditions.
“While the current implementation framework is demonstrably very effective, there is an active public debate about the quantity of reserve supply that it entails,” Perli said in the text of a speech to be delivered before a conference held by the Atlanta Fed.
“The current ample reserves implementation framework is well equipped to handle a reduction in the SOMA portfolio” if there were changes in the financial system that allowed for lower levels of reserves, Perli said.
The official also said that Treasury bill buying the Fed embarked on at the close of last year to rebuild liquidity after several years of shrinking Fed holdings will be managed flexibly going forward. It has already been reduced from buying $40 billion per month to the current pace of $10 billion.
“We stand ready to adjust the pace of (Reserve Management Purchases) up or down as necessary,” Perli said.
Perli’s comments on the effectiveness of the suite of tools the Fed uses to control its short-term interest rate target and market liquidity needs come as a debate has been growing over the future of the central bank’s balance sheet.
The Fed’s balance sheet more than doubled during the COVID-19 pandemic, to a peak of $9 trillion by mid-2022, while it has since fallen to $6.7 trillion.
Incoming Federal Reserve Chair Kevin Warsh has been a critic of how the Fed has used large-scale purchases of Treasury and mortgage bond debt in times of trouble to smooth markets and augment the stimulative power of its short-term interest rate tool.
Warsh has argued that the Fed’s footprint is too large and distorts pricing levels and that the overall size of the Fed’s balance sheet should be smaller. He said doing so would also allow the Fed’s short-term rate target to be lower than would otherwise be the case.
The challenge to that view is that the current toolkit and the markets’ need for reserves limits how far the Fed can shrink its holdings and maintain firm control of the federal funds rate, the Fed’s main tool for achieving its inflation and job mandates.
Those inside and outside the Fed have speculated that an easing in liquidity rules would allow the central bank to move holdings to a lower level. “There are many possible catalysts for a leftward shift in reserve demand, but a plausible one given the current debate is through potential future changes to bank regulatory liquidity requirements,” Perli noted.
But some in the Fed have also noted that there is no cost to providing reserves to the financial system and the size of Fed holdings is a non-issue in the face of a system that has provided very firm control over the setting of monetary policy.
“A key criterion for any implementation framework is effective interest rate control across a range of economic and financial conditions, and on this measure our framework has an excellent track record,” Perli said.
(Reporting by Michael S. Derby in New York;Editing by Dan Burns and Matthew Lewis)
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