This is a highly educative piece on the Federal Reserve’s Balance sheet. What I find interesting is the fact how the Fed wants to tighten liquidity once the economy starts getting better:
Although, in principle, the ability to pay interest on reserves should be sufficient to allow the Federal Reserve to raise interest rates and control money growth, this approach is likely to be more effective if combined with steps to reduce excess reserves. I will mention three options for achieving such an outcome.
First, the Federal Reserve could drain bank reserves and reduce the excess liquidity at other institutions by arranging large-scale reverse repurchase agreements (reverse repos) with financial market participants, including banks, the GSEs, and other institutions. Reverse repos, which are a traditional and well-understood tool of monetary policy implementation, involve the sale by the Federal Reserve of securities from its portfolio with an agreement to buy the securities back at a slightly higher price at a later date. Reverse repos drain reserves as purchasers transfer cash from banks to the Fed. Second, using the authority the Congress gave us to pay interest on banks’ balances at the Federal Reserve, we can offer term deposits to banks, roughly analogous to the certificates of deposit that banks offer to their customers. Bank funds held in term deposits at the Federal Reserve would not be available to be supplied to the federal funds market. Third, the Federal Reserve could reduce reserves by selling a portion of its holdings of long-term securities in the open market. Each of these policy options would help to raise short-term interest rates and limit the growth of broad measures of money and credit, thereby tightening monetary policy.
Overall, the Federal Reserve has a wide range of tools for tightening monetary policy when the economic outlook requires us to do so. We will calibrate the timing and pace of any future tightening, together with the mix of tools, to best foster our dual objectives of maximum employment and price stability.
One thought on “The Federal Reserve’s Balance Sheet: An Update by Ben Bernanke”
The Fed hass to tighten liquidity as Bernanke proposes. Let us all hope he car resist the inevitable political pressure against him doing his job. — http://econometrician.wordpress.com/