Fed’s George urges faster drawdown of $8.5 trillion in assets and ‘more normal’ interest-rate strategy

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The chairman of the Kansas City Federal Reserve said Tuesday that the central bank must sharply reduce its massive $8.5 trillion pile of bond holdings to help stave off the highest US inflation in nearly 40 years.

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Esther George said the Fed’s effort to curb inflation would be more effective if the bank reduced its holdings of longer-term bonds, even as it gradually raised short-term interest rates. She made his remarks in a virtual speech Central Exchange.

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George said the bank should shrink its balance sheet at a faster pace than it did during a similarly critical moment nearly a decade ago as the US was recovering from another sharp recession.

“Overall, I believe it would be appropriate to move first on the balance sheet relative to the previous tightening cycle,” she said.

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The Fed purchased trillions in Treasuries and mortgage-backed bonds during the pandemic to reduce long-term interest rates to record lows and to borrow more and spend.

Yet the economy has largely recovered and the pace of inflation recently hit a 39-year high of around 7% – some economists say is due to additional Fed and White House stimulus.

George said that the economy does not need much help now.

“Even as the pandemic continues to impact economic activity, the time has come to shift monetary policy away from its current crisis stance towards a more normal currency in the interest of longer-term stability,” she said.

The Fed is preparing to raise its benchmark short-term interest rate which is now near zero for the first time since 2018 and determines how quickly to shrink its balance sheet. Chairman Jerome Powell vowed to prevent inflation from developing deep-rooted in testimony to his nomination on Tuesday.

If the Fed raised short-term rates but was slow to shrink its balance sheet, George argued, the yield curve could be inverted and lead to excessive risk-taking.

A reversal occurs when short-term interest rates rise above long-term rates. Lower long-term rates can lead investors to seek higher returns from riskier investments.

“With strong demand, high inflation and a tight labor market, policymakers will need to grapple with the appropriate pace and magnitude of adjustments across multiple policy instruments as they work to achieve their long-term objectives for employment and price stability. do,” said George. , “That transition can be a bumpy one.”

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