Why the Fed's balance sheet matters
Much has been made of the growth of the Fed's balance sheet from around $800 billion before the global financial crisis to over $7.7 trillion today.
What it is: The Fed's balance sheet is the number of assets the Fed holds — akin to an investment portfolio held by the central bank.
Be smart: The balance sheet has grown so large because even when the Fed brings its policy rate to 0% it can only control short-dated interest rates and it also wants to bring down long-dated interest rates like the 10-year Treasury yield that drives mortgages and other consumer borrowing costs.
- Once the Fed has cut interest rates to 0%, "the balance sheet is how you push down further," says former Fed economist Claudia Sahm, a senior fellow at the Jain Family Institute.
Between the lines: The Fed uses its portfolio to influence the economy and its current $7.7 trillion total suggests it is doing a lot of influencing.
- "Rigging the economy, that’s what the Fed is there to do," says Julia Coronado, president of MacroPolicy Perspectives and a former Fed staffer.
- "Congress has given the Fed a job to do — it’s supposed to rig the economy in a favorable way, reduce the amplitude of business cycles, reduce the severity of business cycles, and get us back to work as fast as possible."
How it works: By purchasing U.S. government bonds and mortgage-backed securities (and as of 2020 even corporate bonds from companies like Apple), the Fed increases their price and reduces their yield.
- And since borrowing costs for things like mortgages and auto loans (and markets utilized by Wall Street banks and hedge funds) are based on the yield of U.S. government debt, the Fed's purchases make it cheaper to borrow money, encouraging more individuals and institutions to do so.
- The government finances its debt by issuing bonds for things it can't pay for with tax revenue, so the Fed's balance sheet makes that debt cheaper as well.
The bottom line: The Fed "is more and more active and more and more responsible for the management of not just the Treasury market, but the entire economy," says Quincy Krosby, chief market strategist at Prudential Financial.
- "This is the question: Once a central bank goes down this road, at what point can they extricate themselves?"
Go deeper: How the Fed took control of the economy