Federal Reserve Chairman Kevin Warsh on Wednesday unveiled a broad review of the central bank's policy framework and operational practices, appointing five independent task forces to examine areas he described as central to the conduct of monetary policy. The announcement, made after his first meeting leading the Federal Open Market Committee, suggested that any immediate changes to how the Fed manages its sizable portfolio of securities were unlikely.
"Im appointing a task force in each of five areas that are central to the broad conduct of monetary policy," Warsh said at the press conference following the FOMC meeting. He set expectations for the groups' schedule: "My expectation is the task forces will begin work in the next couple of weeks, and well start to get some more information from them, some more framing of how they see things, starting in the fall, and hopefully most, if not all of them, concluding by year end," Warsh added. He also said, "For each of these independent task forces, Im enlisting some of the very best minds, both inside and outside the economics profession."
The panels will review several functions of the Fed, including how the central bank approaches inflation, its public communications, the use of economic data in policy decisions, and the interplay between productivity and the jobs market. One panel will directly examine an issue that Warsh has repeatedly highlighted - the size and operation of the Feds balance sheet.
Balance sheet concerns and competing views
Warsh, who served as a governor from 2005 to 2011, has been vocal about his concern that the Feds securities holdings have grown too large. He argues those crisis-era acquisitions have led the Fed to accumulate a substantial bond portfolio that, in his view, can distort market signals and push the central bank into making choices that he believes could be better addressed by elected officials.
That perspective is not universally shared. A number of current Fed officials and many economists maintain that the system the Fed uses to implement policy functions effectively to control short-term rates, and that the claim of market distortion is not accurate. The public statement following the FOMC meeting reflected continuity in operational stance, noting that "the Committee reaffirmed its policy of maintaining ample reserves in the banking system."
Operational backdrop - Treasury bill purchases and reserve management
Last week the Fed said it would continue buying Treasury bills over the next month as a technical measure designed to bolster reserves and preserve control of short-term interest rates. That decision will, at least temporarily, increase the size of the Feds holdings. How long this buying will continue remains uncertain: New York Fed officials have indicated that any future purchases will be guided by prevailing market conditions.
The Fed has used large-scale asset purchases historically to calm stressed markets and to amplify the stimulative impact of monetary policy when the policy rate has been near zero. Over time, it has also developed a set of tools for controlling short-term rates that rely on the financial system holding significant quantities of liquidity.
There are practical limits to how much the Fed can pare back its holdings. The central banks securities holdings can be reduced only to the point where tighter money market conditions do not provoke unwelcome volatility in short-term funding markets. That constraint limits the scale and speed of any potential drawdown in the Feds balance sheet.
Future adjustments and timing
Market participants commonly expect that changes to liquidity regulations could permit a meaningful reduction in the Feds holdings. Still, there is little appetite for returning to the operational arrangements in place two decades ago. Observers and experts cited by Warsh and in market commentary also note that any significant overhaul of the balance sheet or supporting framework will likely take considerable time because of the systems complexity.
The task forces represent an organized effort to gather analysis and perspectives on these issues, but Warshs timeline - with working groups starting within weeks, initial outputs in the fall and most work wrapping up by year-end - implies that immediate changes to day-to-day operations are not imminent. The Feds recent commitment to maintain ample reserves and its near-term Treasury bill purchases further underline an operational stance that will persist as the review proceeds.
For market participants and financial institutions, the review offers a window into potential future adjustments to the institutional framework that governs reserves, liquidity, and the size of central-bank holdings. However, the combination of competing views inside the economics profession, the technical limits on shrinking holdings, and the complexity of the system mean that any substantive shifts are likely to be deliberative and gradual.