The Liquidity Effect of the Federal Reserve’s Balance Sheet Reduction on Short-Term Interest Rates
In accordance with the plan it announced in June 2017, the Federal Reserve has begun reducing its $4.2 trillion holdings of Treasury securities, agency debt, and mortgage-backed securities. The potential impact of these asset reductions on long-term interest rates has been the subject of extensive debate. As it sells off assets, the Fed also will be cutting its liabilities, primarily by reducing its supply of reserve balances. This brief focuses on the liquidity effect of draining the reserves. Specifically, it looks at how this reduction could affect short-term interest rates.