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Here's the Fed's plan to unwind its massive $4.5 trillion balance sheet

Here's how the Federal Reserve plans to get rid of the trillions in bonds and other assets it holds.

The vault at a Wells Fargo bank.

During the financial crisis, the Federal Reserve built up a store of roughly $4.5 trillion in Treasurys and other assets, like mortgage-backed securities, on its balance sheet.

Since then, when these assets have come due the Fed has turned around and reinvested the principal back into new assets, maintaining the size of its balance sheet.

Now, nearly a decade after the start of the financial crisis, the Fed has announced its plan for shrinking the size of its balance sheet.

The basic idea is that the Fed will stop reinvesting the principal of securities when they mature.

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Put another way, when a 10-year Treasury on the Fed's books comes due, the money it gets back from that investment will not be used to go out and buy another Treasury.

The slowing of reinvestment will be phased in over time. To start, the Fed will invest money back into the market only if it gets back more than $6 billion in principal returned a month. From there, the "cap" will increase by $6 billion every three months over the course of a year until it hits $30 billion a month.

The Fed said it would ultimately have a balance sheet "appreciably below that seen in recent years but larger than before the financial crisis" in part because the Fed expects banks to maintain higher demand for reserves supplied by the central bank. But that is a pretty broad end point given that the Fed held roughly $800 billion in assets before the financial crisis and $4.5 trillion now.

Here's the full plan via the Fed:

All participants agreed to augment the Committee's Policy Normalization Principles and Plans by providing the following additional details regarding the approach the FOMC intends to use to reduce the Federal Reserve's holdings of Treasury and agency securities once normalization of the level of the federal funds rate is well under way.

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  • The Committee intends to gradually reduce the Federal Reserve's securities holdings by decreasing its reinvestment of the principal payments it receives from securities held in the System Open Market Account. Specifically, such payments will be reinvested only to the extent that they exceed gradually rising caps.
  • Gradually reducing the Federal Reserve's securities holdings will result in a declining supply of reserve balances. The Committee currently anticipates reducing the quantity of reserve balances, over time, to a level appreciably below that seen in recent years but larger than before the financial crisis; the level will reflect the banking system's demand for reserve balances and the Committee's decisions about how to implement monetary policy most efficiently and effectively in the future. The Committee expects to learn more about the underlying demand for reserves during the process of balance sheet normalization.
  • The Committee affirms that changing the target range for the federal funds rate is its primary means of adjusting the stance of monetary policy. However, the Committee would be prepared to resume reinvestment of principal payments received on securities held by the Federal Reserve if a material deterioration in the economic outlook were to warrant a sizable reduction in the Committee's target for the federal funds rate. Moreover, the Committee would be prepared to use its full range of tools, including altering the size and composition of its balance sheet, if future economic conditions were to warrant a more accommodative monetary policy than can be achieved solely by reducing the federal funds rate.

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