The Federal Reserve is on a journey to shrink its bloated balance sheet but hasn't clarified its destination.
This month the Federal Reserve begins the long journey toward normalizing the size of its balance sheet. Over the past decade, it has engaged in a series of large-scale asset purchases in its support of the economic recovery. These purchases expanded its balance sheet from $900 billion in 2008 to $4.5 trillion in 2014, a five-fold increase. Since then, the Fed has been waiting for the right time to begin unwinding its asset holdings and return its balance sheet to a normal size.
The Fed has decided that time is now. This is welcome news, but we are still somewhat in the dark as to where the journey will end.
What we do know are the reasons why the Fed made this decision. First, Fed officials believe the economic recovery is complete, so stimulus from a large balance sheet is no longer needed. Consequently, shrinking the balance sheet is necessary to avoid overheating the economy.