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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)
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