Federal Reserve Report Defends Use of New Tools to Set Interest Rat...

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Federal Reserve Report Defends Use of New Tools to Set Interest Rates
Report is released ahead of Fed Chairman Jerome Powell's congressional testimony next week

WASHINGTON-The Federal Reserve defended having the flexibility to set interest rates by using relatively new tools that include paying interest to banks, in its semiannual report to Congress on Friday.
Fed Chairman Jerome Powell is scheduled to testify on Capitol Hill over two days beginning Tuesday in the Senate as part of hearings mandated by law. The Fed released its report ahead of those hearings. Some lawmakers, particularly in the House of Representatives, have criticized the Fed in recent years for the use of new facilities that enabled the central bank to guide short-term interest rates higher while maintaining a much larger portfolio of bonds and other assets than existed before the 2008 financial crisis.
Those criticisms reflect in part broader concern on the part of those lawmakers with the emergency steps the Fed undertook from 2008 through 2014 to stimulate growth after the central bank cut interest rates to near zero.
The report released Friday included a three-page overview of its new tools that could serve as a pre-emptive rebuttal against any further concerns lawmakers might raise next week.
The Fed dramatically expanded its bond portfolio after the 2008 financial crisis as it unleashed successive campaigns to stimulate the economy by purchasing Treasury and mortgage securities. Those purchases swelled the amount of deposits, known as reserves, that banks maintain in accounts at the Fed.
The vast increase in reserves, which rose to more than $2.5 trillion in 2014 from about $15 billion in 2007, made it harder for the Fed to change interest rates by buying or selling securities in the open market, as it had before 2008.
In order to raise its benchmark federal-funds rate without first draining its bond holdings and the accompanying bank reserves, the central bank implemented new tools to guide the fed funds rate in a certain range, including by paying interest on those reserves.
Without the new tools, the Fed "would not have been able to gradually raise the federal-funds rate" while maintaining a larger portfolio, the report said. Instead, it would have had to consider "a rapid and sizable eduction" to the bond portfolio to push up borrowing costs.

Question: Why would "a rapid and sizable reduction" to the bond portfolio to push up borrowing costs?

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In my opinion, a rapid and sizable reduction of the Fed’s bond portfolio will result in increased borrowing costs by virtue...

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