U.S. monetary policy is tightening, as everyone who pays even the slightest attention to the financial news knows. But when and how?  Here, the discussion is focused on two complementary aspects of Federal Reserve policy: interest rates and the balance sheet. The first of these concerns policy of the old-style conventional type. The second is about the consequences of quantitative easing. At $4.23 trillion, more than 5 times the 2007 level, the size of securities holdings raises a series of questions: When will the Federal Reserve’s Open Market Committee (FOMC) start to shrink its balance sheet?  How will they do it? How far will they go?  And, most importantly, what will be the consequences for the stance of monetary policy?

On the first two―when and how―the minutes of the March 14-15, 2017 FOMC meeting provide the answers: later this year, the FOMC expects to instruct the open market operations staff at the New York Fed to stop reinvesting the proceeds from maturing securities. Consistent with the policy normalization principles published in September 2014, there is no hint that they will actively sell securities.

The key uncertainty is how far they will go. At this stage, there is little indication of a consensus on how big or small the balance sheet should be at the end of the process. Even if this uncertainty is clarified, however, any additional impact from balance sheet policy on the stance of policy probably will be limited....