Fed Balance Sheet

The Fed balance sheet is the weekly balance sheet belonging to the Federal Reserve, the United State's central bank. It formulates the monetary policy of a nation. It tracks the money supply in the economy to control inflation or deflation by changing economic policies which control the banks' interest rates.

The Fed balance sheet is unique as it expands by buying treasury from the money it prints electronically. Unlike the traditional balance sheets, the central bank updates this balance sheet weekly. The balance sheet changes in the wake of employment generation, inflation control, price stability, or handling interest rates in the long term.

• The Fed balance sheet represents the assets and liabilities of the United States Federal Reserve. 
• The assets of this balance sheet are government securities, mortgage-backed securities & repo rates, whereas liabilities are US dollars, money in the reserves & reverse repos. 
• The quantitative squeezing and quantitative expanding tools help reduce and increase the Fed's balance sheet, respectively.
• During the recession, the Fed increased balance sheets by buying securities to increase the money supply and create jobs. Then, after its normalcy or during inflation in the economy, it uses the quantitative squeezing or unwinding of the balance sheet by stopping the purchase of securities or letting them mature and eliminate from the balance sheet.

Fed Reserve balance sheet refers to the balance sheet of the Federal reserves of the United States of America, which is also known as its central bank. It manages all its liabilities and assets in a detailed balance sheet. The main objective of the balance sheet is to promote employment, price stabilization, and a long-term but moderate interest rate. Moreover, economic stability and maintaining the dollar valuation are also the agenda of the Fed using its balance sheet. 

The current Fed balance sheet size is $8.94 trillion. The Fed balance sheet chart represents it as below:

The Fed regularly monitors the balance sheet to check the assets and liabilities it needs to change for proper growth or inflation control.

Here is a classification of what constitutes the assets and liabilities of Fed’s balance sheet.

#1 - Fed's Assets

Assets are resources with economic or financial value or future cash flow benefits. Anything that the Fed purchases are an asset. The Fed decides the holding, expanding, or shrinking of its assets. The multitudes of assets used and listed on its balance sheet are:

1. Government Securities: These securities are 95% of the balance sheet. It includes the United States treasury bills and treasury notes with a maturity period of 2-10 years for Treasury notes and 4-52 weeks for T-bills. Treasury bonds mature after more than 10 years. The total securities are $5.76 trillion as of 31.03.2022.

1. Agency Mortgage-Backed Securities: These are packaged securities containing a basket of home loans that the banks and financial institutions sell to investors. The large-scale asset purchase programs, i.e., LSAPs, help to purchase them. By value, they are the second largest asset types. They are at present $2.72 trillion as of 31.03.2022.

1. Repo Rates: They are the rates that the Fed charges to the commercial banks when they borrow money from it using the repo window. The rates are also called the Federal discount rate. They lend a variety of credit facilities. 

#2 - Fed's Liabilities 

In economics and finance, it means something that individuals, firms, or government legally owes to someone. For example, it includes a financial obligation such as debts/loans payable to other economic entities.

Here are some Fed balance sheet liabilities: 

1. United States Dollars (Currency In Circulation): The US dollars in circulation in the economy of the United States are historically the biggest liability. Bank reserves surpassed them in 2010. However, $2.22 trillion of currency is in circulation in the US as of 31.03.2022.

1. Money In The Reserves: The member commercial banks, along with the depository institutions, have money in their reserves which is also a liability on the balance sheet. Currently,  $4.6 trillion worth of money is present in the reserves as of 31.03.2022.

1. Reverse Repos: These are the treasury borrowals from commercial banks for holding the rate of federal funds. The treasury securities collateralize the reverse repurchase agreements. The total liabilities of the reverse repo agreement are $2.04 trillion as of 31.03.2022.

 As per the situation, the Fed can change its assets by buying or selling the assets like treasury bonds and mortgage-backed securities or bonds to infuse money into the market or absorb the money from it. For example, in a great recession like 2008, the Fed buys a lot of bonds to infuse money into the economy and reduce the bank rates.

Thus, it expands its balance sheet in situations of recession or some major circumstances. An example may include the current ongoing coronavirus pandemic. However, when the economy starts to recover, and the excess money is no longer required to boost economic growth or to curb inflation via increasing the bank rate, it reduces the balance sheet. The balance sheet reduction process is called quantitative reduction unwinding or Fed balance sheet run off.

After expanding the balance sheet during a recession or a pandemic, the Federal reserve has to normalize its balance sheet as it may negatively affect the economy. Hence, the Fed reserve undertakes the balance sheet reduction, quantitative squeezing, or the unwinding process soon after it had hiked the interest rates to absorb the excess money in circulation. 

Moreover, before doing any unwinding process, the Fed decreased its pace of buying new bonds to put a slow brake on expanding the balance sheet. This process is also called tapering. It is a method to keep a check on the expanding balance sheet by phasing out treasury bonds slowly to prevent any shock to the recovering economy. It can conduct the balance sheet reduction in two ways- selling securities and allowing the expiry of the maturing securities.

#1 - Selling Securities

It is one of the riskier methods to reduce the balance sheet by the Fed. It is so because selling securities will lead to unwanted pressure on the bond market, and the interest rate will increase. As a result, the markets may become volatile. 

#2 - Stopping Any Further Purchase Of Bonds 

Another method to reduce the balance sheet by the Fed is to apply the complete breaks to any new purchase of any new bonds and let the existing bonds mature and cease to exist. Again, it helps remove the old securities entries from the balance sheet, decreasing the Fed balance sheet.

The Federal Reserve, a central bank, must maintain its assets and liabilities balance sheet. The balance sheet is often changed to meet the economic challenges, employment generation, control inflation, and management of long-term interest rates. At present, the Fed balance sheet is more than $8 trillion as of June 14, 2022, owing to the crisis of coronavirus outbreak.

Here are the tools that the Fed uses to stabilize and maintain its balance sheet that impacts the economy:

#1 - Quantitative Easing

As regards the impact on the economy by the Fed's balance sheet, the assets of the Fed consist mostly of government-backed and mortgaged-backed securities. Individuals or financial institutions buy these securities at the prevailing rate in return for a good amount of interest paid to them by the government. Moreover, the Fed buys securities from the open market, leading to cash injection and more money supply into the US economy. This process is called quantitative easing, as quoted by economists.

As a result, banks reduce their interest due to the availability of excess money. As soon as the interest rate decreases, many people begin borrowing from the banks. Thus, people have enough money in their hands to spend more on commodities, spurring demand and rejuvenating the economy. It is called the expansion of the Fed balance sheet; the Fed undertook it during the great recession and the coronavirus outbreak. Hence, the Fed balance sheet has swelled to $8 trillion as of 2022.

#2 - Quantitative Tightening

The Fed will try to shrink the balance sheet to normalize the economy. For doing so, the Fed will not buy any new securities and let the previous ones it bought expire until they roll off on their own. The processing of trimming the balance sheet is called quantitative tightening. After that, the Fed removes expired securities from its balance sheet, which removes excess money. As a result, the inflow of money into the market will decrease. So, in short, the bank rate will increase, and lending will become difficult. Hence, inflation will decrease, and the economy will return to normal.

This is a guide to what is Fed Balance Sheet and its definition. Here we explain assets & liabilities of Fed balance sheet, it's working & its impact on economy. You can learn more about economics from the following articles -

• Freddie Mac
• Gross National Income
• Trickle-Down Theory