The Federal Reserve will rely most heavily on its power to pay interest on reserves, rather than asset sales, when the time arrives to tighten monetary policy, though those actions are unlikely for quite a while, a top Fed official said Monday.
Given the still-weak economy and some inflationary pressures, "this is not the time to be removing monetary stimulus," Federal Reserve Bank of San Francisco President Janet Yellen said. "When the day comes to start raising rates again, we have tools at the ready. But, for the time being, the economy still needs the support of extraordinarily low rates," she said.
When it becomes time for the Fed to change gears, Yellen said the Fed's ability to pay interest on reserves banks hold at the Fed will "play a lead" role in the policy response.
This power, according to central bankers, mutes the inflationary power of the Fed's swollen balance sheet by creating powerful incentives for banks to stash excess cash at the Fed, which keeps that money out of the economy.
The policy maker said outright sales of assets the Fed has bought to help lower borrowing costs and support the housing market would be a bad idea for the foreseeable future. "Massive sales of mortgage-related and Treasury securities could be disruptive to markets and cause mortgage interest rates and other long-term rates to shoot up when we are still in the early stages of the recovery, and the financial system, although improving, is still not at full health," Yellen said.
"Eventually, after economic conditions have improved and a policy tightening has begun, we may then start a gradual process of selling securities in order to help return the Fed's balance sheet to its precrisis levels," the official said.
Yellen's comments came from a speech that was to be delivered before an event at the University of San Diego.