One of the Federal Reserve's most important staff members gave some hints Monday about how the central bank could structure a new round of purchases to increase the size of its balance sheet, as markets now widely expect the Fed to do in response to a weak economic recovery.
Brian Sack, who heads the NY Fed’s open market operation, is tasked with carrying out in the market the policy decided by the Federal Open Market Committee in Washington. His group executes the purchases and sales of assets to adjust the size of the Fed’s $2.3 trillion balance sheet. So his comments on how to handle a new round of quantitative easing are more than just idle theoretical musings. He will be doing the buying.
Sack made three points in a California speech Monday:
—First, he said moves in the the Fed’s balance sheet should be persistent. Just as it does with a change in interest rates, Sack said that once the Fed increases the size of the portfolio it should keep it there for a while.
“A change that was expected to be transitory would instead move conditions very little,” Sack said.
"“This anticipation of policy actions is beneficial, as it brings forward their effects and thus helps to stabilize the economy.”"
Importantly, several times in the speech Sack compared increasing the size of the balance sheet to a movement in the funds rate, underscoring how, with the funds rate at zero, buying and selling assets is the Fed’s most important policy tool now.
His speech follows remarks by his boss, New York Fed President Bill Dudley, on Friday in which he made the case for additional quantitative easing.
So it’s essentially a two-step dance, with Dudley saying it should be done and Sack laying out some details of how it could be done. (The FOMC may, of course, decide to do things differently).
—Second, Sack said that the Fed should provide forward-looking information on the size of the Fed’s balance sheet, just as it did with interest rates.
“This anticipation of policy actions is beneficial, as it brings forward their effects and thus helps to stabilize the economy.” Sack said guidance is especially critical now since “financial market participants have no history from which to judge the FOMC’s approach and anticipate its actions.”
—Third, Sack offered that the Fed should maintain flexibility in its approach, “providing some discretion to change course as market conditions evolve and as more is learned about” using the balance sheet as a policy tool.
He said the Fed is only now learning about the costs and benefits, so it doesn’t want to make too hard a commitment. That’s especially true since the balance sheet is likely to change with change in the economic forecasts of Fed officials.
That somewhat contradicts the first two points on being persistent and providing forward guidance. However, it would be unrealistic to think the Fed would box itself into a policy without options to get out if the situation changed drastically.
Sack also suggested that the balance sheet should be adjusted in relatively small steps, not in the massive asset purchases that characterized the first round of QE. He noted that the Fed has traditionally adjusted interest rates in small steps.