Federal Reserve Chair Janet Yellen said on Tuesday that the Fed will begin to shrink its $4.45 trillion balance sheet when the central bank is confident the economy is on a solid course.
Speaking to lawmakers at the Senate Banking, Housing, and Urban Affairs Committee, Yellen offered insight into the central bank's monetary policy plans on the Fed's balance sheet and its path for increasing interest rates.
Following the financial crisis, the Fed began its policy of quantitative easing—the large-scale purchase of Treasury and mortgage-backed securities that inflated its balance sheet to roughly $4.45 trillion.
While proponents of this policy such as former Fed chair Ben Bernanke often claim that this policy helped stimulate the economy, some critics have expressed concern that the policy may lead to high inflation when the excess reserves start to flow out of the banking system.
"We would hope [quantitative easing] was a very unusual intervention and one that we would not frequently be relying on in the future," Yellen said. "The Federal Open Market Committee has enunciated that its longer-run goal is to shrink our balance sheet to levels consistent with the efficient and effective implementation of monetary policy."
Yellen said she could not put a number on how large the balance sheet would remain but she anticipated that it would be substantially smaller than it is now. The chair also said they would prefer to use the federal funds rate as a tool, rather than fluctuations in the balance sheet, since the rate is the one the Fed has the most confidence in and the one that markets best understand.
"What we would like to do is to find a time when we judge that our need to provide substantial accommodation to the economy in the coming years is minimal," Yellen said. "When we have confidence that the economy is on a solid course and the federal funds rate has reached levels where we have some ability to address weakness by cutting it."
"Once we have that confidence, we will try to … allow maturing principal from our investments to gradually and, in an orderly way, we will stop reinvestments or diminish them and allow our balance sheet to shrink in an orderly and predictable way," she said. "The committee has decided that it will not sell mortgage-backed securities but as principal matures we will begin to allow those assets to run off our balance sheet."
The chair also signaled in her testimony that the Fed may raise interest rates at their next meeting in March, saying it would be unwise to wait too long for further accommodation.
"At our upcoming meetings, the committee will evaluate whether employment and inflation are continuing to evolve in line with these expectations, in which case a further adjustment of the federal funds rate would likely be appropriate," the chair said.