The Federal Reserve is the largest bank in the United States and is responsible for national monetary policy. The Fed’s main objective is to increase employment, promote stable prices, and regulate long-term payments. The Fed also contributes to the stability of the financial system, especially in times of economic downturn – or weak economic growth – and financial instability.
The Fed uses various programs and efforts to achieve its goal, and the result is often a change in the Fed’s balance sheet structure. Cash flow can increase or decrease the amount and size of assets or liabilities in its network, which in turn increases or decreases the money supply to the economy. However, some critics say the Fed has gone too far and tried to do more to bring down and trouble.
Federal Reserve Bank Balance Sheet
Like other balance sheets, the Fed’s balance sheet is made up of assets and liabilities. Each week, the Fed publishes an H.4.1 report. This report provides an overview of the asset and liability status of all Federal Reserve Banks.
For decades, federal observers have relied on federal asset movements or liabilities to predict changes in business circles. The 2007-08 financial crisis not only made the Fed’s balance sheet more complex, but also raised public interest. Before we go into the details, it’s a good idea to look first at the Fed’s finances and then their responsibilities.
For much of its history, the Fed’s balance sheet was actually quite a sleepy topic. Issued every Thursday, the weekly balance sheet report (or H.4.1) includes items that might seem at first glance typical of most company balance sheets. It lists all assets and liabilities, providing a consolidated statement of the condition of all 12 regional Federal Reserve Banks. The Fed’s assets consist primarily of government securities and the loans it extends to its regional banks. Its liabilities include U.S. currency in circulation. Other liabilities include money held in the reserve accounts of member banks and U.S. depository institutions. The weekly balance sheet report became popular in the media during the financial crisis starting in 2007. 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 2007-2009 crisis.
The Fed’s Assets
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.S. Treasuries and other debt instruments. More than 60% or nearly $5 trillion of the $7.69 trillion in assets include various types of U.S. Treasuries as of March 17, 2021. 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 Fed owns more than $2 trillion in mortgage-backed securities on its balance sheet as of March 17, 2021.
The assets also include loans extended to member banks through the repo and discount window.6 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.S. Treasury securities. Whether the Fed buys or sells securities, the central bank influences the money supply in the U.S. economy.
The Fed’s Liabilities
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.S. depository institutions also forms a part of the Feds’ liabilities. 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. Of the nearly $7.65 trillion in liabilities as of March 17, 2021, the Fed has just over $2 trillion as currency notes and $5.3 trillion in deposits on its balance sheet.
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. The reserve ratio is the portion of reservable liabilities that commercial banks must hold onto rather than lend out or invest and is currently set at 0% effective March 26, 2020. As this is an asset for commercial banks, it is reciprocally a liability for the central bank.
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