Bernanke Gives Update On Fed Balance Sheet
Chairman Ben Bernanke gave an update on the status of the Federal Reserve’s balance sheet in a speech on Thursday. Although there has been talk lately of the Fed’s impending exit strategy, fears of relapse may make that a long drawn out process.
To fight a recession, the standard prescription for a central bank is to lower its target short-term interest rate, thereby easing financial conditions and supporting economic growth. In the current downturn, however, the Federal Reserve has faced two historically unusual constraints on policy.
First, the financial crisis, by increasing credit risk spreads and inhibiting normal flows of financing and credit extension, has likely reduced the degree of monetary accommodation associated with any given level of the federal funds rate target, perhaps significantly.
Second, since December, the targeted funds rate has been effectively at its zero lower bound (more precisely, in a range between 0 and 25 basis points), eliminating the possibility of further stimulating the economy through cuts in the target rate.
The Federal Reserve has had to take unconventional steps in order to get the financial system back on it’s feet. Normally a backstop for commercial banks, the Fed greatly expanded it’s role by providing liquidity to financial institutions across many sectors and becoming an active buyer in a number of credit markets.
It quickly saw that it’s normal monetary policy initiatives would not be enough to unfreeze credit markets in the wake of the financial panic last fall. It’s balance sheet currently sits at $2.1 trillion and will continue to grow as the Fed finishes up with their agency mortgage securities purchases.
They do have a number of tools at their disposal to shrink their balance sheet when the time comes. However, if the recovery starts to stall the Fed’s balance sheet could remain quite large for some time.
