Question

The following items are a simplified version of very recent balance sheet data relating to the Federal Reserve Bank of the United States of America:

Currency at issue $1,650bn

Accounts due to foreign central banks and others $83bn

Loans to private banks $130bn

Government securities $3,850bn

Government balance $407bn

Exchange settlement account balances $1,867bn

Net foreign currency reserves (and gold) $37bn

Other assets $30bn

1. Classify each of the above individually as either an asset or a liability of the Federal Reserve. .

2. Draw up a balance sheet for the Federal Reserve Bank, using the above data, recording Assets on the left, and Liabilities and Equity Capital on the right. Assume all the assets and liabilities of the Fed have been included in the above list. .

3. Calculate the equity capital of the Federal Reserve Bank. (1 mark).

4. Suppose the Federal Reserve makes a loan of $10bn to the Bank of New York Mellon, which is a private bank. How does this affect the balance sheet of the Federal Reserve? Which item or items change, and by how much? .

5. Suppose the Federal Reserve Bank pays a dividend of $20bn to the U.S. Federal Government. How does this affect the balance sheet of the Federal Reserve? Which item or items change, and by how much? .

6. Can the Federal Reserve Bank go bankrupt? If so, how could this happen? If not, why not? (1 mark).

Answer 1

Currency at issue $1,650bn	Liability
Accounts due to foreign central banks and others $83bn	Liability
Loans to private banks $130bn	Asset
Government securities $3,850bn	Asset
Government balance $407bn	Liability
Exchange settlement account balances $1,867bn	Liability
Net foreign currency reserves (and gold) $37bn	Asset
Other assets $30bn	Asset

Asset	$ Bn	Liability	$ Bn
Loans to private banks	130	Currency at issue	1650
Government securities	3850	Accounts due to foreign central banks and others	83
Other assets	30	Government balance	407
Net foreign currency reserves (and gold)	37	Exchange settlement account balances	1867
Total assets	4047	Total Liability	4007
		Surplus/ Equity	40
		Total Liability and Equity	4047

4- Loan to BNY Mellon
The loan given to the bank is as asset to the Fed and will increase the asset side of the Fed by $10 Bn. The Fed can give the loan in 2 ways- first is to increase the currency at issue i.e. liability by $10 Bn and keep the surplus/ equity constant. This will increase both assets and liabilities of the Fed by $10 Bn. As the Fed is the controller of the currency in circulation, it can print new currency to be introduced in the market. Another way to do is transfer the government securities or treasuries available on the asset side of the Fed to BNY Mellon. This will not impact the liability side but decrease the government securities assets by $10 Bn and increase another asset loans to private banks by $10 Bn.

5- Dividend to USG
The central banks all over the world often pay out a dividend to their respective governments out of their surplus reserves or profits. This operation impacts the balance sheet by increasing the government balance on the liability side of the Fed balance sheet by $20 Bn and decreasing the Surplus/ equity of the Fed by an equal amount, thus matching the total assets in the balance sheet.

6- Fed bankrupt
The central bank can theoretically go bankrupt. The currency in circulation is controlled by the central bank of the country. In countries where the currency is backed by the gold reserves or is linked to some other asset asset or foreign currency, the central bank of those countries can not print or circulate currency on demand. these banks can only print and circulate their currency up to a certain limits. Hence, when the central banks of these countries have liabilities that exceed their capacity to repay, they can go bankrupt. Another way a central bank can go bankrupt is when the foreign currency liabilities increase beyond its capacity to repay. In such case, the central bank can not meet the liability by merely printing domestic currency as this will further depreciate the domestic currency compared to the foreign currency. Coming to the specific case of US Federal reserve- the Us Dollar is a Fiat currency and is not backed by gold or any other asset. Hence, the Fed can print the currency as much as they want and meet the liability demands. The depreciation of the currency is not considered here. At the same time, the USD has a strong foreign exchange value. It is used as a reserve currency all over the world. Hence, the Fed can also use USD to fulfill its foreign currency obligations via USD, without having to purchase the foreign currency. Hence, it can be safely said that under current economic circumstances the Fed can not go bankrupt.