Interest on Reserves and the Fed’s Balance Sheet
The Federal Reserve’s balance sheet has expanded dramatically after three rounds of quantitative easing (QE). Consequently, the monetary base (reserves plus currency) has gone from less than $800 billion before the financial crisis to nearly $4 trillion today. Given that the supply of reserves is now many times greater than the demand for reserves, the Fed now has no alternative other than to pay interest on reserves as it carries out its normalization process.
The transition, or normalization, period during which monetary policy returns to a more normal state should be as short as possible and shorter than currently implied by the Fed’s “Policy Normalization Principles and Plans.”