In response the Fed abruptly cut interest rates to zero, rolled out a raft of emergency lending programs, and began hoovering up trillions in Treasuries and mortgage-backed bonds. The bond-buying is credited with helping stabilize the financial system and, later, to bolster demand and foster a faster recovery from the sharpest downturn in decades. More recently some Fed policymakers have questioned its effectiveness and even raised the alarm over its potential harms amid an economy marked by rising inflation and too much demand relative to pandemic-constrained supply.
They all agree it should be pared back soon, minutes from the Fed's last meeting show. Here is a look back at the arc of the Fed's pandemic bond-buying program - what policymakers said, what the central bank did, and what's likely to lie ahead.
Fed Chair Powell issued a terse and unusual statement Feb. The Fed, he said, is "closely monitoring developments and their implications for the economic outlook" and "will use our tools and act as appropriate to support the economy.
Not only that, but the Fed will lose money even if everything evolves exactly as expected because term premiums are currently estimated to be negative. A few months ago, in a blog post available here , we develop and use a very simple model of the economy to represent the relationship between equilibrium interest rates on reserve balances, Treasuries, bank loans, and deposits at banks, as well as Fed, bank and household holdings of these instruments. The model consists of a household that uses its wealth and bank loans to fund investments in deposits and Treasuries; a bank that uses deposits to fund investments in Treasuries, loans to households and reserve balances; and the Fed, which just uses reserve balances from banks to fund purchases of Treasuries.
The household and the bank both seek to hold balanced portfolios of assets and respond to relative interest rates on their assets and liabilities. In the previous blog, we considered what happens to bank loans when the Fed buys part of the existing stock of Treasuries. As shown in the bottom panel of the exhibit, when the Fed buys the additional Treasuries, there is a corresponding increase in reserve balances.
To fund and make room for the added reserve balances, banks increase deposits by We emphasize that the numbers, and the model, are just illustrative. In order to make room on their balance sheets, banks then hold fewer Treasuries and lend less to the real economy. If the bank must satisfy a leverage ratio requirement, and the leverage ratio does not exclude reserves, the effects are similar but a bit larger not shown.
Currently, for the last few years, and for the foreseeable future, it is expected to be cheaper to borrow long-term than to borrow short-term and roll over the short-term debt. Long-term interest rates consist of two pieces: 1 the average roughly expected short-term interest rate until maturity, and 2 a term premium. These estimates have been negative for a couple years and the forward term premiums estimated by the models indicate term premiums will remain negative for five or more years.
When the Fed buys Treasuries, it is converting, on average, five-year Treasury securities into overnight borrowing. Other liabilities include money held in the reserve accounts of member banks and U. The weekly balance sheet report became popular in the media during the financial crisis starting in When launching their quantitative easing in response to the ongoing financial crisis, the Fed's balance sheet gave analysts an idea of the scope and scale of Fed market operations at the time.
In particular, the Fed's balance sheet allowed analysts to see details surrounding the implementation of an expansionary monetary policy used during the crisis. The essence of the Fed's balance sheet is similar to any other balance sheet since anything for which the Fed has to pay money becomes the Fed's asset. In other words, if the Fed were to hypothetically buy bonds or stocks by paying newly issued money for it, those investments would become assets.
Traditionally, the Fed's assets have mainly consisted of government securities , such as U. Treasuries and other debt instruments. Treasuries as of March 17, The Treasury securities include Treasury notes , which have maturity dates that range from two to 10 years, and Treasury bills , or T-bills, which have short-term maturities such as four, eight, 13, 26, and 52 weeks.
The other significant amount of assets on the Fed's balance sheet include mortgage-backed securities , which are investments that are made up of a basket of home loans.
These fixed-income securities are packaged and sold to investors by banks and financial institutions. The assets also include loans extended to member banks through the repo and discount window. The Fed's discount window is a lending facility for commercial banks other depository institutions. The Fed charges an interest rate—called the federal discount rate —to banks for borrowing from the Fed's discount window.
When the Fed buys government securities or extends loans through its discount window, it simply pays by crediting the reserve account of the member banks through an accounting or book entry. In case member banks wish to convert their reserve balances into hard cash, the Fed provides them dollar bills. Thus, for the Fed, assets include securities it has purchased through open market operations OMO , as well as any loans extended to banks which will be repaid at a later time.
The open market operations refer to when the Fed buys and sells securities in the market, which are usually U. Treasury securities. Whether the Fed buys or sells securities, the central bank influences the money supply in the U.
One of the interesting things about the Fed's liabilities is that currency in circulation, like the green dollar bills in your pocket, are reflected as liabilities. Apart from this, the money lying in the reserve account of member banks and U. As long as the dollar bills lie with the Fed, they would be treated as neither assets nor liabilities.
The dollar bills become the Fed's liabilities only when the Fed puts them in circulation by purchasing assets. The size of different components of the Fed liabilities keeps on changing. For instance, if the member banks wish to convert the money lying in their reserve accounts into hard cash, the value of the currency in circulation would increase, and the credit balance in reserve accounts would decrease. But overall, the size of the Fed's liabilities increases or decreases whenever the Fed buys or sells its assets.
The Fed also requires commercial banks to hold on to a certain minimum amount of deposits, known as reserves. As this is an asset for commercial banks, it is reciprocally a liability for the central bank. The Fed can very well discharge its existing liabilities by creating additional liabilities. The Fed can't, in any manner, be compelled to discharge its liabilities in terms of any other tangible goods or services.
At best, you could receive government securities by paying back in dollars whenever the Fed is selling. Beyond this, the Fed's liabilities are only as good as something written on a piece of paper. In a nutshell, paper promises beget only other kinds of paper promises. This will alert our moderators to take action. Nifty 18, Market Watch. ET NOW. Brand Solutions. Video series featuring innovators. ET Financial Inclusion Summit. Malaria Mukt Bharat.
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