The Federal Reserve System is the central bank of the United States and conducts the nation's monetary policy. The primary goals of the Fed's monetary policy are to promote maximum employment, stable prices, and moderate long-term interest rates. The Fed also seeks to ensure the stability of the financial system.
The Fed uses its balance sheet to help it accomplish those goals. The Fed decides what assets it holds, and whether to expand or shrink its holdings. When the Federal Reserve buys debt instruments like Treasury notes or mortgage-backed securities, it is seeking to increase their price and lower yields, while signaling a looser monetary policy to support the economy. Conversely, the sale of Fed assets is a policy tightening approach that constrains financial conditions and asset values.
The Federal Reserve has dramatically expanded its securities holdings to cushion the economic shocks of the 2008 global financial crisis and, later, the COVID-19 pandemic.
- The Federal Reserve regularly discloses the assets and liabilities on its balance sheet
- The Fed's assets include Treasuries and mortgage-backed securities purchased under large scale asset purchase programs (LSAPs).
- Fed liabilities include U.S. currency in circulation and the reserves deposited by commercial banks.
- During economic crises, the Fed can expand its balance sheet by buying more assets under LSAPs, a policy also known as quantitative easing (QE).
The Balance Sheet of the Federal Reserve Bank
The Fed's assets consist primarily of U.S. Treasury notes and bonds and agency mortgage-backed securities. Its liabilities are mostly U.S. currency in circulation, bank reserves held in Fed accounts, and reverse repurchase agreements collateralized by Treasury securities.
Financial market participants have long tracked changes in the Fed's balance sheet to monitor its implementation of monetary policy. Large scale asset purchases first used to address the global financial crisis increased the complexity of the Fed balance sheet, drawing heavy public scrutiny.
The Fed's Assets
Anything the Federal Reserve buys is an asset. Since the Federal Reserve has an unlimited supply of currency for asset purchases, the size of its balance sheet is constrained primarily by the availability of eligible assets as well as practical considerations of politics and policy.
Traditionally, the Fed's assets have mainly consisted of U.S. Treasury securities. Treasury securities, primarily notes and bonds, accounted for $5.76 trillion of the Fed's $8.94 trillion in assets as of March 31, 2022.
Treasury notes are issued in maturities ranging from two to 10 years, while Treasury bonds have maturities of more than 10 years. Treasury bills, or T-bills, are short-term debt with maturities of four, eight, 13, 26, and 52 weeks.
Mortgage-backed securities, which entitle buyers to cash flows from a basket of mortgage loans, are the second largest asset type by value on the Fed's balance sheet. These fixed-income securities are created and sold to investors by banks and financial institutions, including government-sponsored enterprises like Fannie Mae and Freddie Mac. The Fed owned $2.72 trillion of mortgage-backed securities as of March 31, 2022.
Other Fed Assets
Fed assets also include loans extended to banks through the repo and discount window, lending under a variety of credit facilities established to support smooth functioning of credit markets and economic growth, and foreign currency held under central bank liquidity swaps ensuring the availability of dollars for foreign institutions.
The Fed's Liabilities
Currency in circulation, including a significant proportion in use overseas as well as any dollar bills in your pocket, was historically the largest Federal Reserve liability, until it was surpassed in 2010 by bank reserves on deposit with the Fed. Since 2019, the overnight rate the Fed pays on bank reserves has been its primary tool in setting the federal funds rate.
Fed liabilities of $8.9 trillion as of March 31, 2022 included $4.6 trillion in deposits by banks and the U.S. Treasury, $2.22 trillion in Federal Reserve notes (i.e., currency in circulation), and $2.04 trillion in reverse repurchase agreements.
Reverse repurchase agreements, or reverse repos, are borrowings of Treasuries from commercial counterparties used to hold the federal funds rate in the Fed's targeted range.
When a bank converts some of its Fed reserve balance into currency, it increases currency in circulation and decreases reserves on deposit with the Fed accordingly without changing the overall level of Fed liabilities.
The Fed's Balance Sheet Expansion
Quantitative easing (QE), or large scale asset purchases were first used by the Fed in the wake of the 2008 global financial crisis to address the zero lower bound problem, which is what happens when a central bank drops short-term rates to zero but the economy fails to return to its expected growth trajectory.
In addition to directly lowering long-term interest rates by purchasing long-dated securities, quantitative easing is also intended to signal the central bank's bias toward looser monetary policy as a further growth spur. The signaling function of quantitative easing has at times ensured that benchmark bond yields rose while the Fed was buying only to drop once the purchase program was discontinued.
The Federal Reserve conducted three rounds of large scale asset purchases between 2008 and 2014. The Fed resumed asset purchases on a dramatically expanded scale amid the economic slump in the early stages of the COVID-19 pandemic, buying $1.7 trillion of Treasury securities between the middle of March and the end of June in 2020.
The Bottom Line
All of us are connected to the Fed's balance sheet in one way or another. The currency notes that we hold are liabilities of the Fed, as are bank reserves boosted by our deposits. The Fed's assets include a range of credit lines established to ensure the economy's stability at times of crisis, as well as U.S. Treasuries we also hold in investment portfolios. Changes in the level and composition of the Fed's balance sheet can ultimately affect all U.S. consumers and businesses.