(Adds details from Q&A)
By Mark Felsenthal and Emily Kaiser
ARLINGTON, Va., March 8 The U.S. Federal
Reserve will likely shrink its vast holdings of
mortgage-related and other longer-term securities passively and
gradually, a senior Fed official said on Monday.
"A decision to shrink the balance sheet more aggressively
could be disruptive to market functioning," Brian Sack,
executive vice president at the Federal Reserve Bank of New
York, told the National Association for Business Economics.
The assets will roll off fairly quickly with time, he said,
adding that an aggressive approach to diminishing the Fed's
holdings would risk a spike in longer-term interest rates.
The Fed is close to completing its scheduled purchases of
around $1.7 trillion of mortgage-backed securities, agency debt
and longer-term Treasuries it launched to boost the economy
after cutting rates to near zero.
The Fed has said high unemployment and low inflation make
it necessary to hold rates exceptionally low for an extended
But with evidence the economy has begun to recover from the
worst financial crisis in generations, Fed officials have begun
to explain how the U.S. central bank plans to unwind its
extraordinary support for the economy.
Some Fed officials argue that the Fed should actively sell
assets to help steer its tightening of financial conditions.
Sack said that while reversing the Fed's low rates and
massive infusions of cash into the economy will involve steps
it has never taken before, he is confident the central bank has
"We have worked hard to ensure we have all the tools needed
to exit," he said. "If we communicate effectively, the markets
should be clearly informed and well-prepared ahead of any
Sack said assets would begin to shrink on their own. For
example, the Fed estimates that more than $200 billion of
mortgage-related debt it holds will mature or be prepaid by the
end of 2011.
In addition, about $140 billion of Treasury securities
mature between now and the end of 2011, he said.
As the Fed proceeds, it will lay out a path for interest
rates as well as asset holdings, Sack said.
However, what the Fed says about the likely direction of
its policy after its meetings is likely to be a more important
guide to markets about the path of short-term interest rates
than any decisions about draining reserves from the system, he
"It will be difficult for market participants to make
precise inferences about the timing of increases in the target
interest rate from the patterns of reserve draining alone,"
Discussing the future of Fed policy, Sack said the
financial system may function better if banks' reserves are
higher than they were before the financial crisis struck.
The Fed's monetary policy-setting committee had not yet
decided whether to shrink reserves in the system to pre-crisis