By Michael S. Derby
NEW YORK (Reuters) – The Federal Reserve faces no imminent pressure to stop the ongoing contraction of its balance sheet, according to a new tool launched Thursday by the Federal Reserve Bank of New York.
The new gauge, which the bank calls Reserve Demand Elasticity, seeks to measure how liquid bank reserves, a key aspect of financial sector liquidity, are. The bank said the new measure will help Fed officials better manage the uncertain process of cutting their holdings of bonds, in a process called quantitative tightening, or QT.
The new tool is designed to serve as an early warning indicator of impending reserve scarcity. The bank said in a blog posting that the measure will help spot the transition point between abundant levels of liquidity, toward the “ample” but undefined level of reserves policymakers say they are aiming for.
As of data available on Oct. 11, the measure indicates “reserves remain abundant. These latest RDE estimates are indistinguishable from zero, meaning that the federal funds rate does not significantly respond to shifts in reserve supply.” For reference, negative RDE readings suggest tighter liquidity.
The QT process has been running for a little over two years, with the Fed contracting the overall size of its holdings from a peak of $9 trillion to the current level of $7.1 trillion. The Fed is seeking to withdraw unneeded liquidity as part of an overall normalization of monetary policy in the wake of the coronavirus pandemic.
(Reporting by Michael S. Derby; Editing by Chizu Nomiyama)
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