Fed Chairman Ben S. Bernanke signaled as much last month, telling reporters, “I emphasize that given the outlook . . . these matters are unlikely to be relevant to actual policy for quite a while.”
The central bank dived into uncharted territory in response to the financial crisis, and there is no precedent for how to get out. The Fed got a preview of just how tricky the task could be last month when markets tanked after it broached the possibility of scaling back its $85 billion in monthly purchases of long-term government and mortgage bonds. It took public remarks by nine top Fed officials to calm investors, and mortgage rates remain elevated.
The communications challenge probably will be even more formidable when the Fed is ready to raise interest rates and shrink its balance sheet. Already there is some disagreement among the central bank’s top brass over how the process should work.
The exit strategy approved two years ago called for the Fed to sell its portfolio of mortgage-backed securities over three to five years, but minutes of the Fed’s policy-setting meeting in June show that most officials now believe the central bank should hold on to that debt.
Part of the reason is that the portfolio has grown so large — totaling more than $1 trillion — that shedding it in such a short time frame could disrupt the market. Proponents also argue that holding the debt delays shrinking the Fed’s balance sheet only by about a year.
However, a few officials, such as Richmond Fed President Jeffrey Lacker, have pushed for a rapid withdrawal from the mortgage market.
Lacker has opposed the purchases from the start and cited the potential for capital losses if the Fed holds on to the bonds. That could leave the central bank without any proceeds to return to the Treasury, an unusual position that could draw public and congressional backlash.
In addition, Lacker said the Fed has achieved its goal of turning around the real estate market.
“We ought to be thinking about pulling away from the housing market since it’s strengthening so much,” he said in an interview. “It would be regrettable if we held [mortgage-backed securities] so long that we overstimulated the housing market.”
The Fed put off deciding the issue at its last meeting, according to the minutes. It is unlikely to begin shrinking its balance sheet for at least two years.
“Although most participants saw this review as prudent longer-range planning, some felt that the discussion was premature,” the minutes read. “Additional discussion regarding policy normalization should be deferred.”
The sale of mortgage bonds is not the only component of the Fed’s plans that is being questioned. The central bank has vowed to keep interest rates low at least until the unemployment rate hits 6.5 percent or inflation reaches 2.5 percent. In a speech last week, Philadelphia Fed President Charles Plosser advocated automatically hiking rates once those conditions are met. In contrast, Minneapolis Fed President Narayana Kocherlakota has called for lowering the unemployment rate threshold to 5.5 percent.