What Is the Fed Balance Sheet?
The Fed balance sheet is a financial statement published once a week that breaks down the assets and liabilities held by the Federal Reserve (Fed). The report, formally known as the "Factors Affecting Reserve Balances," essentially outlines the factors that affect both the supply and the absorption of Federal Reserve funds, and helps to shed light on the means the central bank uses to inject cash into the economy.
- The Fed balance sheet is a weekly report that lists the Federal Reserve's assets and liabilities.
- The report outlines what the Fed is doing to expand or contract its balance sheet as it implements its monetary policy.
- Since the 2007-2009 financial crisis, the Fed balance sheet has reflected the Fed's use of quantitative easing (QE) to keep interest rates low for banks and increase the money supply.
Understanding the Fed Balance Sheet
The Fed is the United States' central bank and was founded by Congress in 1913 to ensure the stability and safety of the nation's financial and monetary structures.
For much of its history, the Fed's balance sheet was a sleepy topic. Issued every Thursday, the weekly balance sheet report (or H.4.1) includes items that might seem at first glance typical of most company balance sheets. It lists all assets and liabilities, providing a consolidated statement of the condition of all 12 regional Federal Reserve Banks.
The Fed's assets consist primarily of government securities and the credit it extends to member banks and other financial institutions (FIs). Its liabilities, meanwhile, include primarily deposits held with the Fed by member banks and the Treasury, as well as U.S. currency in circulation—other than that held by the Fed itself.
The weekly balance sheet report became more important as a financial and economic indicator during the financial crisis starting in 2007, when the Fed initiated a policy of quantitative easing (QE). The Fed balance sheet gave analysts insight into the scope and scale of Fed market operations at the time. In particular, it allowed analysts to see details surrounding the implementation of the unconventional QE expansionary monetary policy, which has been in use ever since.
The Fed Balance Sheet and Quantitative Easing (QE)
QE is a monetary policy in which a central bank purchases large quantities of government securities or other securities from the market to increase the money supply beyond what it would otherwise do through normal open market operations.
Previously the Fed would buy (or sell) securities to add (or withdraw) bank reserves to reach a target interest rate in the overnight interbank market—the Fed funds rate. However, this kind of policy is thought to be inherently limited during periods when the Fed’s target rate is at or near zero. In these cases, instead of targeting interest rates, the Fed can target specific quantities of reserves to issue (and assets to buy) with the aim of flooding the financial system with liquidity to ease credit conditions, regardless of the zero percent lower bound on rates.
Using the Fed's balance sheet through QE was at first somewhat controversial. Although these efforts certainly helped ease bank's liquidity issues during the financial crisis, critics contend that QE can massively distort the operation of financial markets and the allocation of real investment in the economy, as well as create significant risk of long-run price inflation.
These critics have largely been ignored by policymakers. In fact, the Fed has engaged in multiple, successive rounds of QE, resulting in a considerable expansion of its balance sheet in the years since 2007.
What makes the Fed's balance sheet vastly different than corporate balance sheets is the Fed's ability to create new money at will. The central bank can almost instantaneously expand its balance sheet by electronically “printing” money and crediting it to the reserve accounts of primary dealers and borrowers from the Fed.
In the process, the Fed simultaneously uses this money to buy assets, such as U.S. Treasury notes (T-notes). Similarly, the Fed can contract its balance sheet by selling its assets. This rapid expansion and contraction of its balance sheet is part of the Fed's monetary policy and can have profound and long-lasting effects on the economy.