Skip to content

How Is Normalization of Monetary Policy Going to Work?

Monday, August 3, 2015
inflation expectations and fed credibility
Shutterstock/M DOGAN

Each issue of The Regional Economist, published by the Federal Reserve Bank of St. Louis, features the section “Ask an Economist,” in which one of the Bank’s economists answers a question. The answer below was provided by Vice President and Economist Stephen Williamson.

How is normalization of monetary policy going to work?

Monetary policy normalization refers to the steps the Federal Open Market Committee (FOMC)—the Federal Reserve's monetary policymaking body—will take to remove the substantial monetary accommodation that it has provided to the economy since the financial crisis began in 2007. The committee has made it very clear that normalization is going to be data-driven. In other words, policy decisions will be based on the future performance of inflation, labor markets and gross domestic product (GDP), among other things.

In its "Policy Normalization Principles and Plans," announced in September 2014, the FOMC laid out a program that would ultimately allow the Fed to conduct monetary policy in essentially the same way it did before the beginning of the financial crisis. The principles and plans outline a sequence of actions by which normalization will be achieved:

  1. "Liftoff"—The FOMC will raise its interest rate target when it deems there is no longer as great a need for monetary accommodation. Liftoff is expected to happen sometime later in 2015, but, again, the timing of liftoff will be data-driven, not calendar-dependent.
  2. End "reinvestment"—The FOMC wishes to ultimately reduce the Fed's balance sheet to a size such that the quantity of interest-earning liabilities (including bank reserves) is small, as was the case before the financial crisis. Reinvestment is the process of replacing assets on the Fed's balance sheet as they mature; so, when reinvestment ends, the balance sheet will begin to shrink. 
  3. Shrink balance sheet—Balance-sheet reduction will occur slowly, with no plans to sell assets, though this option has not been ruled out. The Fed's assets will decline as Treasury securities and mortgage-backed securities (MBS) mature. While Treasuries mature at a predictable rate, MBS do not, as this depends on the rate at which the mortgages backing the MBS are refinanced and on mortgage defaults.

Federal Reserve Board economists estimate that the normalization process will take about seven years once it starts.

Additional Resources

Posted In Federal ReserveFinancial  |  Tagged stephen williamsonmonetary policyfomcnormalizationgreat recessionfederal reserve
Commenting Policy: We encourage comments and discussions on our posts, even those that disagree with conclusions, if they are done in a respectful and courteous manner. All comments posted to our blog go through a moderator, so they won't appear immediately after being submitted. We reserve the right to remove or not publish inappropriate comments. This includes, but is not limited to, comments that are:
  • Vulgar, obscene, profane or otherwise disrespectful or discourteous
  • For commercial use, including spam
  • Threatening, harassing or constituting personal attacks
  • Violating copyright or otherwise infringing on third-party rights
  • Off-topic or significantly political
The St. Louis Fed will only respond to comments if we are clarifying a point. Comments are limited to 1,500 characters, so please edit your thinking before posting. While you will retain all of your ownership rights in any comment you submit, posting comments means you grant the St. Louis Fed the royalty-free right, in perpetuity, to use, reproduce, distribute, alter and/or display them, and the St. Louis Fed will be free to use any ideas, concepts, artwork, inventions, developments, suggestions or techniques embodied in your comments for any purpose whatsoever, with or without attribution, and without compensation to you. You will also waive all moral rights you may have in any comment you submit.
comments powered by Disqus

The St. Louis Fed uses Disqus software for the comment functionality on this blog. You can read the Disqus privacy policy. Disqus uses cookies and third party cookies. To learn more about these cookies and how to disable them, please see this article.