The Federal Reserve substantially expanded its portfolio, or balance sheet, during and after the Great Recession. Although the Fed has since shrunk its balance sheet, it has decided to hold a much bigger portfolio of bonds than it did before the Great Recession. As a result, the way in which the Fed influences short-term interest rates now is quite different than it was before 2008. Here’s how.
What is the Fed’s balance sheet?
Like any financial institution, the Federal Reserve’s balance sheet consists of liabilities (mainly outstanding currency plus funds that banks deposit at the Fed in what are known as “reserves”) and assets (mainly U.S. Treasury debt and mortgage-backed securities). What makes the Fed unique is that it can expand its balance sheet at will by (electronically) printing money (technically, bank reserves) and using that money to buy Treasury debt on the open market. The Fed posts details of its balance sheet regularly.
What’s been going on with the Fed’s balance sheet?
The Fed’s balance sheet expanded by over $3.5 trillion during and after the Great Recession as a result of trillions of dollars in bond-buying, known as quantaitive easing (QE). At its peak, the balance sheet was around $4.5 trillion, or the equivalent of 25 percent of GDP, compared to $850 billion, or 6 percent of GDP, before the Great Recession. The Fed began shrinking the balance sheet in October 2017 by not reinvesting the proceeds of all the bonds in its portfolio when they mature, a process that the Fed calls “balance sheet normalization” but others call “quantitative tightening.” This process has been criticized by some in financial markets and by President Donald Trump, who regard it as unwarranted tightening of monetary policy. The Fed argues that its primary monetary policy tool remains short-term interest rates and that the balance sheet normalization is a much more gradual change happening in the background. Furthermore, the shrinking of the balance sheet has not increased long-term interest rates by as much as some expected. The Fed says it plans to end the shrinking of the balance sheet by September. Fed Chair Jerome Powell has estimated that the balance sheet will end up at about $3.5 trillion, or 17 percent of GDP.
How does a large balance sheet change the way the Fed influences interest rates?
The Fed used to set interest rates by adjusting the supply of bank reserves. Banks are required to keep a minimum amount of reserves at the Fed. Because the Fed historically didn’t pay interest on these reserves, banks avoided keeping any more reserves than they needed to at the Fed, and instead lent “excess reserves” overnight to other banks that needed it in the federal funds market. The Fed influenced the interest rate at which reserves were borrowed or lent – the federal funds rate – by buying or selling Treasury securities in that market and adjusting the supply of bank reserves accordingly. The federal funds rate is a benchmark interest rate for all other short-term rates in the economy.
美联储过去常常通过调整银行准备金来设定利率。银行必须在美联储保留最低储备金额。由于美联储历史上没有支付这些储备的利息，银行避免再储备超过美联储所需的储备金，而是在一夜之间向联邦基金市场中需要它的其他银行提供“超额准备金”。美联储通过在该市场买卖国库券并相应调整银行准备金来影响借入或借出储备的利率 - 联邦基金利率。联邦基金利率是经济中所有其他短期利率的基准利率。
In 2008, after Congress gave it authority to do so, the Fed began paying interest on required and excess reserves (IOER). Instead of buying and selling Treasuries to adjust the supply of reserves and influence the fed funds rate, it influenced the fed funds rate by setting the IOER. No bank would lend reserves to another bank at a rate less than the rate it could receive by simply keeping cash parked at the Fed, so changes in the IOER tended to change the federal funds rate. (For a variety of reasons, federal funds have traded a tick below IOER in practice.) Under this approach, banks are willing to hold large amounts of deposits at the Fed because they are remunerated at market rates. This approach has been described as an “ample reserves” framework in contrast to the previous approach, which has been dubbed a “scarce reserves” framework. The new approach is also known as a “floor” system because the Fed’s IOER, set by fiat, establishes a floor on the federal funds rate. Under this approach, the Fed’s balance sheet will remain much larger than it was prior to the financial crisis.
Why did the Fed decide to keep its balance sheet larger than it was before the financial crisis?
One, the demand for currency – $10, $20, $100 bills – grows over time as the economy grows and prices rise. Despite all the talk of cashless transactions, there is still a strong global demand for currency. Since the Great Recession began, currency in circulation has more than doubled, from $829 million to $1.7 billion.
其一，随着经济增长和价格上涨，货币需求--10美元，20美元，100美元的账单 - 随着时间的推移而增长。尽管谈论无现金交易，但全球对货币的需求依然强劲。自大萧条开始以来，流通货币已经增加了一倍以上，从8.29亿美元增加到17亿美元。
Two, and more significant, banks’ desire to hold reserves has increased. Since the financial crisis, the Dodd-Frank Act and other regulations increased banks’ capital and liquidity requirements. That is, banks are now required to maintain larger cash buffers to safeguard against a major shock like the one that happened in 2008. Recent research by the New York Fed estimates the minimum reserve balances that would be required for the eight largest domestic banks to meet their liquidity needs during a banking panic on a single day could be as high as $933 trillion. Since reserves maintained at the Fed are banks’ main source of cash, banks’ overall demand for reserves is now much higher than it was prior to the crisis, as a result of regulation.
两家银行持有储备的愿望有所增加。自金融危机以来，“多德 - 弗兰克法案”和其他法规增加了银行的资本和流动性要求。也就是说，银行现在需要维持更大的现金缓冲，以防止像2008年那样发生的重大冲击。纽约联邦储备银行最近的研究估计，八大国内银行需要达到的最低准备金余额在一天的银行业恐慌期间，他们的流动性需求可能高达933万亿美元。由于美联储维持的储备是银行的主要现金来源，由于监管，银行对储备的总体需求现在远高于危机前的储备。
In addition, there are some technical reasons why banks might want to hold reserves more than Treasury securities (both of which are considered very safe, high-quality liquid assets under current regulations), related to the timing of intraday settlements and requirements under banks’ resolution planning, or “living wills.” Indeed, the Fed’s survey of primary dealers in March shows a median expectation that banks will maintain at least $1.2 trillion of reserves. Before the crisis, reserves never rose above $46 billion.
The changes to the size of the Fed’s balance sheet and the way it influences interest rates do not mean that the Fed is either tapping the brakes or pressing on the accelerator to influence the economy. This is simply a change in the way the Fed influences interest rates, as Chair Powell and other Fed officials have said.
What about the composition of the Fed’s balance sheet?
In addition to deciding the size of its balance sheet, the Fed has to decide which securities it will hold: Will it hold only Treasury securities, or will it also hold mortgage-backed securities (MBS)? Will it hold more short-term Treasury securities or more long-term Treasury securities? Holding MBS has been controversial; some see it as an unwise intervention in the markets that favors housing over other assets. Some members of Congress have called the Fed’s MBS purchases a form of fiscal policy, arguing the Fed is allocating credit to the housing sector instead of other parts of the economy, a decision usually left to Congress. The Fed has decided to return its balance sheet to a Treasuries-only portfolio eventually. It hasn’t decided on the composition of that Treasuries-only balance: more longer-term Treasury bonds or more shorter-term Treasury bills. Prior to the crisis, about half the Fed’s holdings of Treasury securities matured in one year or less; today, that’s about 18 percent.
This was an intentional feature of the Fed’s crisis programs. In particular, the Fed’s Maturity Extension Program (MEP), also known as Operation Twist, was created to sell short-term treasuries and purchase long-term treasuries to lower long-term interest rates, which are important for business loans and mortgages. Research on the Fed’s asset purchase programs, including the MEP, estimate that they reduced the term premium (the additional interest that investors require to invest in longer-term bonds relative to several short-term bonds) by about 1 percentage point.
Boston Fed President Eric Rosengren has made the case that the Fed should shorten the average maturity of its balance sheet so that if it needs to implement a policy like Operation Twist in a future downturn, selling short-term bonds and buying long-term bonds, it has the ability to do so. But Chicago Fed President Charles Evans thinks this might not be the best idea. He argues that shortening the maturity of the Fed’s portfolio would increase longer-term interest rates and tighten financial conditions. To offset this, the Fed would have to keep interest rates lower during normal times, giving it less room to cut rates during the next recession. In May, Chair Jerome Powell noted that the Fed’s policy committee – the Federal Open Market Committee – had started to discuss this issue and plans to address it towards the end of 2019.
波士顿联邦储备银行行长埃里克罗森格伦曾表示，美联储应该缩短其资产负债表的平均到期日，以便在未来经济衰退时需要实施像扭曲操作这样的政策，出售短期债券并购买长期债券，它有能力这样做。但芝加哥联储主席查尔斯埃文斯认为这可能不是最好的主意。他认为，缩短美联储投资组合的成熟度将提高长期利率并收紧金融环境。为了抵消这一点，美联储将不得不在正常时期保持较低的利率，从而减少在下一次经济衰退期间降息的空间。今年5月，主席杰罗姆鲍威尔指出，美联储的政策委员会 - 联邦公开市场委员会 - 已经开始讨论这个问题，并计划在2019年底解决这个问题。
What concerns are there with the Fed’s new operating framework?
Though the Fed’s intention of implementing a floor system with ample reserves was done in part to maintain better control over interest rates, some economists, including David Beckworth of George Mason University, worry that this system isn’t working so well in practice. Recently, various short-term rates have risen and been unusually volatile. In particular, the federal funds rate has increased towards the top of the Fed’s target range. As a result, the Fed has made several technical adjustments to bring the federal funds rate down, lowering the IOER such that the spread at which it is set relative to the top of fed funds rate target is wider. Despite this tweak, various other short-term interest rates important for market functioning that traditionally trade below the IOER have risen above it. If the Fed can’t maintain control over interest rates, then it might have to make tweaks to its new “ample reserves” framework.
How can the Fed improve its control over short-term interest rates?
To give the Fed better control over interest rates, Bill Dudley, former president of the New York Fed, argues that the Fed should scrap the federal funds rate altogether as a target. The federal funds rate is a vestige of the old system, so attempts to control it are moot, he argues. Instead, the Fed should just focus on using rates that it controls directly, such as IOER and other administered rates. Economists at the Federal Reserve Board and the St. Louis Fed have argued (here and here) that the Fed should create a standing repurchase (repo) facility to keep short-term interest rates from rising above target and to decrease the overall demand for bank reserves at a given level of the IOER; the Fed has said it wants to see reserves at the smallest level consistent with conducting monetary policy efficiently and effectively. A repo facility would allow banks to borrow cash on a short-term basis from the Fed at slightly above market interest rates whenever they need it, similar to the Fed’s discount window, so they wouldn’t have to park so much money in reserves at the Fed. It also would effectively put a ceiling on short-term interest rates; no bank would borrow at a higher rate than the one they could get from the Fed directly. This might help keep the federal funds rate from rising above the Fed’s target. The IOER would serve as a floor for the federal funds rates and the rate on the standing repo facility would serve as a ceiling. Chair Powell said that the facility would be discussed by the FOMC in future meetings.
为了让美联储更好地控制利率，纽约联邦储备银行前总裁比尔•达德利（Bill Dudley）辩称，美联储应该完全废除联邦基金利率作为目标。他认为，联邦基金利率是旧制度的遗迹，因此试图控制它是没有实际意义的。相反，美联储应该只关注使用它直接控制的利率，例如IOER和其他管理利率。联邦储备委员会和圣路易斯联邦储备银行的经济学家（在这里和这里）都认为，美联储应该建立一个常设回购（回购）机制，以保持短期利率不超过目标并降低对银行的整体需求在给定的IOER水平上储备;美联储已表示希望将储备视为最低水平，与高效率地实施货币政策相一致。回购设施允许银行在需要的时候以短期高于市场利率的方式从美联储借入现金，类似于美联储的贴现窗口，因此他们不必在储备金中存入这么多钱。美联储。它还将有效地对短期利率设定上限;任何银行都不会以比他们直接从美联储获得的利率更高的利率借款。这可能有助于保持联邦基金利率不会超过美联储的目标。 IOER将作为联邦基金利率的底线，而常设回购设施的利率将作为上限。鲍威尔主席表示，FOMC将在未来的会议上讨论该设施。