Fed’s George urges faster drawdown of $8.5 trillion in assets and ‘more normal’ interest-rate strategy
The president of the Kansas City Federal Reserve said the central bank should move soon to reduce its enormous $8.5 trillion pile of bond holdings to help curb the highest U.S. inflation in almost 40 years.
Esther George on Tuesday said the Fed’s effort to reduce inflation would be more effective if the bank drew down its holdings of long-term bonds even as it gradually raised short-term interest rates. She made her remarks in a virtual speech to the Central Exchange.
George said the bank should reduce its balance sheet at a faster pace than it did during a similar pivotal moment last decade as the U.S. was recovering from another sharp recession.
The central bank started to trim its balance sheet in mid-2017, more than two years after it raised interest rates for the first time since the 2007-2009 Great Recession. And it did so slowly, starting at $10 billion a month.
“All in all, I believe that it will be appropriate to move earlier on the balance sheet relative to the last tightening cycle,” George said. She did not specify a timeframe.
Roberto Perli, head of global policy research at Cornerstone Macro, predicted in a research note that the Fed would start to reduce its balance sheet by $20 billion a month starting as early as March and no later than June.
He said the moves would be twice as large because the Fed’s balance sheet is double the size compared to start of the pandemic. The central now holds $8.7 trillion in assets vs. $4.2 trillion a few years ago.
The Fed bought trillions in Treasurys and mortgage-backed bonds during the pandemic — at a pace of $120 billion a month — to push down long-term interest rates and spur more borrowing, spending and investing. Mortgage rates fell to record lows.
Yet the economy has largely recovered and the pace of inflation recently hit a 39-year high of nearly 7% — in part, some Wall Street DJIA,
George said the economy no longer needs much assistance.
“Even as the pandemic continues to influence economic activity, the time has come to transition monetary policy away from its current crisis stance towards a more normal posture in the interest of long-run stability,” she said.
The Fed is preparing to raise its benchmark short-term interest rate that is now near zero for the first time since 2018 and determine how quickly to reduce its balance sheet. Chairman Jerome Powell in his renomination testimony on Tuesday pledged to prevent inflation from developing deep roots.
If the Fed raised short-term rates but was slow to reduce its balance sheet, George contended, the yield curve could invert and cause excessive risk-taking.
An inversion occurs when short-term interest rates rise above long-term rates. Low long-term rates can induce investors to seek higher returns from riskier investments.
“With robust demand, high inflation, and a tight labor market, policymakers will need to grapple with the appropriate speed and magnitude of adjustments across multiple policy tools as they work to achieve their long-run objectives for employment and price stability,” George said. “That transition could be a bumpy one.”
