The Federal Reserve waited until seven years after the 2008 financial crisis to start raising near-zero interest rates.

And the next year, 2016, when the U.S. central bank had signaled it would make as many as four 25 basis-point hikes, it ultimately made only one.

With that history, just how realistic is its current projection of three increases this year and next while simultaneously trimming a balance sheet that ballooned to $4.5 trillion with the purchase of securities intended to buoy a fragile economy?

At least some members of the Fed's monetary policy committee aren't sure, which is prompting debate about when the central bank should start trimming its current policy of reinvesting the proceeds of maturing government bonds and mortgage-backed securities, according to minutes of the panel's June meeting. 

"Several preferred to announce a start to the process within a couple of months," according to the minutes, a timetable in keeping with projections from economists at Morgan Stanley (MS) and Goldman Sachs Group Inc.  (GS) .

Others preferred waiting longer, both because of inflation that stubbornly lags the Fed's 2% target and concerns that "a near-term change to reinvestment policy could be misinterpreted as signifying that the committee had shifted toward a less gradual approach to overall policy normalization."

Should the central bank be forced to make a choice between the two, it's likely to prioritize trimming the balance sheet, Bank of America economist Michelle Meyer has predicted.

"The balance sheet policy is less dependent on data than rate hikes," she wrote in mid-June. "We now expect the Fed to announce the change to the balance-sheet policy in September and push out the next hike to December. However, if data improve and financial conditions are favorable, it is possible that the Fed will deliver both in September."

Getting the timing right is crucial for the Fed, as it seeks to preserve economic growth and labor-market gains while reducing the stimulus measures established after the financial crisis, a period when unemployment surged to a peak of 10% and U.S. equity markets lost about half their value.

Shrinking the balance sheet, which expanded more than five-fold from just $869 billion before the crisis, is particularly important because it would begin to reduce the central bank's deep involvement in global financial markets. It would also curb incentives for companies to load up on cheap debt and help the Fed skirt criticism over its payment of above-market interest rates on foreign lenders' deposits.

The central bank hasn't said how much it expects to trim, with Chair Janet Yellen specifying only that it's targeting "levels appreciably below those seen in recent years, but larger than before the financial crisis."

Goldman economists, however, have offered a more precise projection: That the Fed will cut its holdings by just $1.1 trillion, or about 25%, a process that would take until late 2020 under a plan capping monthly reductions at $50 billion.

The Fed, which stopped adding to its portfolio in 2014, expects to achieve the cuts by gradually paring how much of the proceeds from maturing securities it reinvests, acting slowly enough to avoid spooking financial markets.

Reinvestment reductions will be capped at $10 billion initially, and the limit will increase by that amount every three months until it reaches a maximum of $50 billion.

The total is derived by combining a $6 billion initial limit on Treasury notes that gradually climbs to $30 billion with a $4 billion starting cap on maturing agency debt and mortgage-backed securities that moves incrementally toward $20 billion.

Editor's Pick: This article was originally published July 5, 2017. 

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