WASHINGTON With its inflation and unemployment goals in sight the U.S. central bank should begin decreasing the size of the mammoth balance sheet accumulated during its battle against the 2007 to 2009 financial crisis, St. Louis Federal Reserve Bank President James Bullard said on Tuesday.
Maintaining the Fed's current $4.4 trillion in securities and other assets as it begins to raise its policy rate, Bullard said, means the central bank is in effect pushing up short-term borrowing costs while its asset holdings pull down long-term rates.
That "twist" in the yield curve is something the Fed has not debated as a policy choice, Bullard said, and could be prevented by letting the balance sheet begin to shrink. As it stands the Fed reinvests any Treasury or mortgage holdings that mature each month, maintaining its total stock of holdings. It has said that practice would continue until the process of raising interest rates to a more normal level was "well underway."
"Ending balance sheet reinvestment may allow for a more natural adjustment of rates across the yield curve," Bullard said, and also give the Fed more room to react with new asset purchases in the event a new crisis develops.
Bullard's call for the balance sheet "runoff" to begin now puts him in the minority, at least publicly. Fed officials have begun discussing the timing and process of balance sheet reduction, and considering whether it needs to remain larger than the few tens of billions of dollars needed to manage monetary policy before the crisis.
He does not think interest rates need to rise much farther given the likelihood that low growth will continue.
But allowing the balance sheet to shrink now would free "policy space" for the Fed down the road.
"We should be allowing the balance sheet to normalize naturally now, during relatively good times," he said in evening remarks at George Washington University.
(Reporting by Howard Schneider; editing by Diane Craft)