Just the Facts: The Federal Reserve
Background of the Federal Reserve System
- The Federal Reserve System, founded in 1913 through the Federal Reserve Act, is the central banking system of the United States. There are 12 Federal Reserve banks in the United States, most of them in large cities.
- The banks are jointly responsible for implementing monetary policy set forth by the Federal Open Market Committee, which influences interest rates, among other economic market factors. The overarching goal of the Fed is to stabilize prices, as well as help America reach full employment levels.
- As the central bank of the United States, the Federal Reserve retains control of country’s credit. When the Fed wants to lower or raise interest rates, it buys or sells treasuries from its member banks, which essentially has the same effect as printing money.
- The 12 Federal Reserve Banks provide banking services to both the federal government as well as established depository institutions. For depository banks, they provide payment services such as providing loans and distributing currency. For the federal government, the Reserve Banks process treasury checks, hold a percentage of the national debt, as well as transfer and redeem U.S. government securities.
Highlights of the Federal Reserve Announcement
- The Federal Reserve announced on Wednesday, June 14th that it is raising its benchmark interest rate to a range of 1% to 1.25%, although inflation has been decreasing nationwide. The last time the Fed increased the benchmark rate was in March 2017.
- Chairwoman Yellen said that the Fed is watching the low inflation rates closely, but remains confident that the rate will rise to around 2% in the next few years due to the shrinking unemployment rate and a tight labor market.
- The Fed confirmed on Wednesday that it plans to reduce its $4.5 trillion portfolio in treasuries and mortgage-backed securities later this year.
What is the Federal Reserve Balance Sheet?
- Just like any other balance sheet, the Fed’s balance sheet consists of assets and liabilities. The Fed acquires assets when it pays for something, such as a security or a bond. The Federal Reserve’s assets are mainly made up of government securities, loans given out to member banks, and bonds.
- The Fed’s balance sheet automatically grows when the Fed buys assets, and contracts when it sells them. The Fed buys assets whenever it intends to increase the money supply and keep interest rates low, and sells assets when it intends to increase interest rates by decreasing the money supply.
Why has the Balance Sheet gotten so big?
- During the financial crisis of 2007-2009, the Fed was forced to buy an enormous amount of poisonous assets in order to keep rates low and stabilize the economy. These assets, such as subprime mortgages, were almost worthless and therefore very hard to sell. Banks, hedge funds, and similar institutions held vast quantities of these toxic assets around 2007, and once the markets realized that the assets were worthless, massive institutions became insolvent. The U.S. government bought these assets in order to save the economy, and has essentially had them ever since.
- The government engaged this practice did this for 6 years, which was eventually dubbed “quantitative easing.”
- The Fed had assets worth $858 billion on Aug 1, 2007, and now has about $4.5 trillion as of summer 2017.
The Balance-Sheet Plan
- To shrink the balance sheet, the Fed said it would gradually reduce the amount of monetary proceeds that it gets from maturing securities, and allow some to runoff. Basically, the Fed will stop reinvesting the money it gets back, shrinking the asset portfolio.
- The Wednesday announcement detailing the interest rate hike as well as the balance-sheet reduction plan is important, because it signifies the Fed’s intentions to raise borrowing costs across the nation after 10 years of historically low interest rates. This economic attitude exemplifies the Fed’s optimistic view of American economic conditions.
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