Question

The Federal Reserve is redefining central banking. By lending widely to businesses, states and cities in its effort to insulate the U.S. economy from the coronavirus pandemic, it is breaking century-old taboos about who gets money from the central bank in a crisis, on what terms, and what risks it will take about getting that money back. And with large-scale purchases of U.S. Treasury securities, the Federal Reserve is stretching the boundaries for what a central bank will do to finance soaring federal debt—actions that move it deeper into political decisions it usually tries to avoid. Economists project the central bank’s portfolio of bonds, loans and new programs will swell to between $8 trillion and $11 trillion from less than $4 trillion last year. In that range, the portfolio would be twice the size reached after the 2007-09 financial crisis and nearly half the value of U.S. annual economic output.

1. What is the current size of the Federal Reserve balance sheet in absolute terms and as a % of GDP? (Hint: You may want to check out federalreservemonetarypolicy. To find the value of the balance sheet as a % GDP, you have to use the current yearly nominal GDP.)
2. How does the current size of the Federal Reserve balance sheet as a % of nominal GDP compare to the Great Depression (1929-1939) and World War II (1939- 1945)? (Hint: You may want to google historical view of the Fed’s balance sheet for this question.)
3. What steps is the Fed taking to support state and local governments?
4. Why is the Fed's balance sheet expanding at this pace?

Answer 1

Fed balance sheet is 21 percent of GDP, for 1929 great depression was 23 percent of GDP and after world war II it was 20 percent of GDP.

Source: St Louis Fed Historical data.

Coronavirus has had huge impact on economic growth due to lockdown and shutdowns and social welfare losses.

The economic growth remains subdued as Aggregate demand and consumption both fall simultaneously also leading to fall in prices and inflation.

Investment is pumped out due to falling interest rate regime and lower economic outlook of companies.

Government spending is ramped up due to an expansionary fiscal policy by reducing taxes and spending. Also net exports go negative as imports surge due to supply shocks.

Negative growth in GDP causes high unemployment and lower inflation based on Philips curve movement.

Thus in short run, aggregate supply is high but aggregate demand is low and real GDP falls. However in long run the economy stabilises.

The US has been great in fiscal stimulus of 484 billion dollars and US Fed unlimited bonds buying programmes worth 2 trillion dollars with rate cuts, CRR and SLR and liquidity coverage ratio cuts. Triggering automotic stabilizers and combined above policy will help alleviates financial distress and grow economic growth throufh higher consumption and disposable incomes.

The supplyvof credit availability rises causing its demand to go down considerably.

Sijce the interest rates are cut, the banks shall transmit easier loans availability at lower rates and thus loan markets will grow enormously.

The balance sheet thus expands due to excessive lending and through bind buying programmes since 2008 and post quantitative easing till Coronavirus pandemic.

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