Fed weighs merits of jumbo portfolio in post-crisis era

Mon Dec 14, 2015 1:56pm EST
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By Jonathan Spicer and Ann Saphir

NEW YORK/SAN FRANCISCO (Reuters) - Once the Federal Reserve lifts interest rates from near zero, likely this week, the focus will turn to the other legacy of the crisis-era policies: the Fed's swollen balance sheet.

The prevailing view is that the U.S. central bank's $4.5 trillion portfolio, vastly expanded by bond purchases aimed at stimulating the economy, will have to shrink once rates are on their way up, and the Fed will just need to decide how quickly.

Now, however, there is a new twist to the debate, with some policymakers and outside experts saying that there are reasons to keep the balance sheet big.

Arguments in favor of a leaner pre-crisis era Fed portfolio have been well laid out. A smaller balance sheet would mark a return to "normal" policy, minimize the Fed's impact on the allocation of credit across the economy, and help defuse political pressure from critics accusing the Fed of overextending its influence beyond its core monetary mandate.

As recently as September 2014, the Fed pledged to eventually "hold no more securities than necessary," in its "normalization" plan, a level widely interpreted as close to its pre-crisis $900 billion size.

Today as the long-anticipated rate lift-off draws close, the central bank appears to be warming to the idea of a sizeable balance sheet.

A "permanently higher balance sheet ... is something that we haven't studied that much but I think needs a lot more thought," John Williams, president of the San Francisco Fed, said last month.

A big Fed portfolio could help stabilize financial markets by inducing banks to keep greater amounts of money in reserve, advocates say.   Continued...

The Federal Reserve headquarters in Washington September 16 2015.  REUTERS/Kevin Lamarque