Yellen wants to leave the Fed's balance sheet alone for now

Real estate mortgagesDrew Angerer/Getty ImagesNew townhouses are under construction June 23, 2015 in Northeast Washington, DC.

Wall Street has been abuzz at the prospect that, rather than just raising interest rates to tighten monetary policy, the Federal Reserve could actually forego a key crisis era policy related to mortgages as well.

In response to the worst housing downturn in modern US history, the Fed bought billions worth of mortgage-backed securities in an effort to thaw frozen credit markets. It has also maintained a policy where, as those bonds mature, the principal amount is reinvested in new mortgage-backed securities.

A string of Fed officials recently referenced the possibility the central bank could halt such reinvestments, something the Fed officially suggested it might do once the process of raising interest rates was well under way.

However, asked about the matter during Congressional testimony on February 14, Yellen showed a clear preference for not using the balance sheet as a policy-tightening tool.

“The committee would like to the maximum extent possible to rely on variations on our short-term rate,” Yellen said.

She’s right. The whole point of using the balance sheet as an active policy tool, even though its impact is less certain, was that interest rates had already been brought down to zero as of December 2008.

Critics of the bond buying programs, known as quantitative easing or QE, warned that it would lead to runaway inflation. They were very wrong. Instead, inflation has struggled to even reach the Fed’s 2% target, suggesting the labour market is still too weak to push up wages significantly.

When moving in the other direction, central bankers have the privilege of relying on policy steps that give them greater confidence. Why mess around?

This is an opinion column. The thoughts expressed are those of the author.

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