Introduction
Thank you to our speakers for participating in this event today, and to Joyce, FIASI, and all of the organizers for making it happen. This is the third consecutive year that the New York Fed has co-hosted the Women in Fixed Income conference, which provides us with an opportunity to exchange ideas and build relationships across the industry.
As today’s panelists noted, market participants have been focused on the outlook for the Federal Reserve’s monetary policy and recent developments in policy implementation. After more than three years of balance sheet reduction, the FOMC ended runoff last fall, then determined in December that reserves had reached ample levels, consistent with the principles and plans it had outlined in 2022.1
I’d like to focus my remarks today on the Federal Reserve’s balance sheet.2 I’ll start with some background on the key elements of our operating framework and how Fed balance sheet mechanics work. Then, I’ll discuss recent balance sheet developments and the introduction of reserve management purchases. And I’ll conclude with a few words about the path ahead for the balance sheet.
Before I begin, I’ll make the usual disclaimer that my remarks today reflect my own views and do not necessarily represent those of the New York Fed or the Federal Reserve System.
Core Elements of the Framework
The Open Market Trading Desk (the Desk) at the New York Fed implements monetary policy on behalf of the Federal Open Market Committee (FOMC), which establishes a target range for the federal funds rate in order to achieve its dual mandate goals of maximum employment and price stability. By influencing short-term interest rates, monetary policy affects the availability and cost of credit in the economy.
Currently, the FOMC uses an “ample reserves” framework—meaning that it supplies enough reserves to control short-term interest rates primarily through administered rates, rather than through active management of the supply of reserves.3
Administered rates serve as the Fed’s principal tool in an ample reserves framework (Panel 1) to maintain the policy rate—the federal funds rate—within the target range. The rate of interest paid to banks on their reserve balances, or what we refer to as “IORB,” acts as a benchmark against which banks evaluate their short-term borrowing and lending opportunities. Since banks can earn IORB, they have little incentive to lend funds in the market at rates below what they can earn from the Fed—helping to create a floor on the federal funds rate. To further support control of the policy rate, the FOMC sets the rates for two standing open market operations: overnight reverse repo (ON RRP) and standing repo (SRP).
The ON RRP provides counterparties—most of which are ineligible to earn IORB, such as money market funds and the government-sponsored enterprises—with an investment alternative at a rate set to help reinforce the floor under the policy rate. In a similar fashion, the SRP helps to dampen upward pressure on money market rates by incentivizing counterparties to conduct repos with the Desk when market rates exceed the SRP rate. SRP counterparties, which are primary dealers and certain banks, are able to, and should, use the operations when it is economically sensible for them to do so.
Together, these tools help to maintain the federal funds rate within the FOMC’s target range by encouraging liquidity to flow across the financial system at rates consistent with that range. The tools help mitigate the risk that broader money market pressures could compromise control of the federal funds rate and also support smooth market functioning, even as liquidity conditions fluctuate.4
Federal Reserve Balance Sheet Mechanics
But what exactly are reserves? Which factors affect their demand and supply? And how do we maintain them at an “ample” level? I’ll discuss each question in turn.
Reserves are the balances that banks hold in their Fed accounts and are liabilities on the Fed’s balance sheet. They are the safest and most liquid assets in the financial system. Today, reserves total around $2.9 trillion, as shown on the right side of the stylized balance sheet (Panel 2). In surveys, banks tell us that their demand for reserves reflects several factors, including intraday payment needs, prudent liquidity management, and regulatory considerations.5 Over time, demand for reserves can change for a variety of reasons, including in response to economic growth, structural changes in banking and payments, and shifts in financial sector regulations; demand can also shift suddenly in times of stress.6
But reserves are not the only liability on the Fed’s balance sheet.7 The Fed’s liabilities supply safe assets to the financial system, including currency in circulation and deposits held by various institutions. These liabilities tend to grow over time and, in some cases, have become more variable. Their movement also impacts the supply of reserves—consistent with balance sheet mechanics that I’ll briefly discuss.
Currency in circulation, which is the supply of paper money you may carry in your wallet, has tended to increase alongside nominal economic growth and the international demand for dollars. It is the largest non-reserve liability and stands at $2.4 trillion today.
The Treasury General Account (TGA) is essentially the U.S. Treasury’s “checking” account at the Fed. TGA balances have also grown with the economy and alongside the expansion of the federal debt.8 In this stylized version of the balance sheet, the TGA is around $950 billion, though this balance can fluctuate substantially on a seasonal basis.
Other liabilities include the FIMA reverse repo pool, which provides an overnight dollar investment to foreign official and international account holders, and deposits held by designated financial market utilities and other institutions. Preferences for safe assets can vary meaningfully over time and impact the size of these liabilities.
On the assets side of the balance sheet, the largest component is the System Open Market Account (SOMA), which is the Fed’s portfolio of Treasury and agency securities. Assets on the Fed’s balance sheet are matched by liabilities and capital.
Absent offsetting changes on the assets side, trend growth in non-reserve liabilities will mechanically deplete the supply of reserves. Moreover, seasonal or unexpected increases in the Fed’s liabilities could further reduce reserve balances, potentially to levels below what banks demand. Maintaining an ample level of reserves allows the Fed to meet the demand from banks and to accommodate growth and variability in non-reserve balance sheet liabilities that impact the supply of reserves. In order to ensure an ample supply of reserves as we move forward, the Fed’s balance sheet assets must adjust to match the demand for the Fed’s liabilities.9
Maintaining Ample Reserves
I’ve discussed how the Fed uses an ample reserves framework. But what exactly do we mean when we talk about an “ample” level of reserves?
As shown in the stylized demand curve, ample is not a fixed point (Panel 3). Its precise boundaries are uncertain and can vary over time alongside shifts in banks’ demand for reserves. Conditions in money markets provide us with information about where we are operating along the demand curve.
When reserves are within the ample region, money market rates tend to trade in a relatively stable manner around the IORB rate. Shifts in reserve balances will likely lead to only modest changes in the federal funds rate. Counterparties may occasionally turn to SRP or ON RRP operations when temporary rate pressures emerge, around such periods as reporting dates, Treasury securities settlements, and tax payment dates. A modest amount of money market rate volatility helps provide information about market conditions and also incentivizes appropriate risk management, including ahead of these periods when temporary rate pressures can arise.10
When reserves move to higher levels of ample, money market rates could move lower relative to administered rates, and we might see some liquidity absorbed by the ON RRP. At lower levels of ample, we might observe increases in money market rates relative to administered rates. There may also be greater usage of SRP operations to provide liquidity, when it is desired by counterparties.
However, drops in reserve supply below the ample region could result in elevated levels of volatility in money market rates and threaten the Fed’s control of its policy rate. Excessive volatility can raise the risk of strained market functioning, making it harder for market participants to redistribute liquidity and access funding, including financing for Treasury securities.
Recent Balance Sheet Developments
In order to ensure that reserves remain at ample levels in the face of shifts in the Fed’s liabilities, the FOMC in December directed the Desk to begin reserve management purchases (RMPs) to grow the SOMA portfolio. The decision came in response to the rapid tightening of money market conditions late last year as reserves declined. RMPs are designed to preserve effective rate control and do not represent a change in the stance of monetary policy. The size of RMPs will be determined by demand for Fed liabilities.
The Desk publishes its updated purchase schedule each month, and earlier today announced that it would purchase an additional $40 billion in Treasury bills through mid-March.11 As noted in December, the Desk expects purchases to remain around elevated levels until mid-April.12 This pace reflects staff forecasts for expected increases in non-reserve liabilities in April. In fact, the U.S. Treasury recently estimated that TGA balances could peak around $1.025 trillion by late April, amid tax season inflows, likely resulting in a notable drawdown in reserves.13 Together with standing open market operations, a gradual addition of reserves through RMPs between now and then seeks to ensure that reserve balances remain ample enough to cover any increases across non-reserve liabilities with minimal market disruption.14 After mid-April, we anticipate the amount of purchases to be reduced substantially.15
Looking ahead, monthly purchase amounts will likely vary based on the outlook for reserves supply and demand, judgment about market conditions, and how these are expected to evolve. Our forecasts for reserves supply will reflect trend growth and expected seasonal shifts in the Fed’s non-reserve liabilities, including currency and the TGA. But, as with any forecast, there is always uncertainty about how variables move and interact. In this case, there is notable uncertainty about how demand for Fed liabilities will evolve and how that might impact the appropriate supply of reserves.
Given this uncertainty, we use a range of indicators to shape our RMP plans. We rely on surveys to deepen our understanding of the underlying demand for reserves, and market data and the intelligence we gather help inform our assessment of market conditions.16 In addition to the information embedded in market prices, usage of ON RRP and SRP can yield important signals about the boundaries of the ample region, as well as any variation in the demand for reserves or their distribution across the banking system. Importantly, usage of these operations will continue to support rate control as the supply of and demand for reserves varies over time—and from our expectations.
In conclusion, the Desk’s objective remains straightforward: to maintain an ample supply of reserves so that monetary policy, as determined by the FOMC, is implemented efficiently, interest rate control is effective, and markets continue to function smoothly. We will continue engaging with the market around the demand for reserves and underlying factors that drive that demand. We appreciate your input as we work to ensure our tools support monetary policy implementation and the FOMC’s goals. Thank you.
