By Jane Ihrig, Associate Director and Economist, Federal Reserve Board of Governors
Before the financial crisis, the Federal Reserve’s balance sheet stood at less than $1 trillion, 6% of gross domestic product (GDP). Today, the balance sheet is $4 trillion, 20% of GDP. With policymakers signaling that balance sheet normalization is close to complete, why might the balance sheet remain more than triple its precrisis level?
The answer is that the majority of the increase reflects market participants’ increased demand for Fed liabilities. And, importantly, balance sheet normalization does not mean the Fed’s balance sheet will hold steady at this new level going forward. Instead, once normalization has been reached, the Fed’s balance sheet will most likely begin a gradual expansion.
The table provides a simplified version of the Fed's balance sheet prior to the financial crisis and today.
|Dec. 27, 2006||April 3, 2019|
|Treasury General Account||$5||$270|
|Other Liabilities and Capital||$74||$355|
|SOURCE: H.4.1 Statistical Release.|
At the end of 2006, the size of the balance sheet was under $1 trillion. Of the Fed’s assets, the majority were securities, with the Fed holding about $800 billion in Treasuries.
On the liability side, U.S. currency in circulation around the world stood near the same size as securities holdings, while reserve balances were a modest $13 billion, and the Treasury had a policy to hold $5 billion in its checking account (the Treasury General Account) at the Fed.
Turning to today, securities again represent the vast majority of assets, but they now stand at more than $3.7 trillion.Securities holdings peaked at $4.2 trillion immediately after the end of the third large-scale asset purchase program in 2014 and remained at this size as the FOMC reinvested maturing and prepaying securities through October 2017. In addition, the composition of the Fed’s securities holdings has changed vastly, moving to a portfolio with about $1.6 trillion in mortgage-backed securities holdings today. On the liability side of the balance sheet, we see large increases in key line items.The February 2019 Monetary Policy Report discussed the role of various liabilities in determining the size of the Fed's balance sheet. Currency has more than doubled to about $1.7 trillion. Whether one looks at the past few years or the last decade, currency grew on average 6% a year. This reflects both domestic and international demand for U.S. dollars, with a large share of $100 bills held abroad.
Reserves stand at about $1.6 trillion, significantly above their precrisis level but down 40% from their peak in 2014. The Federal Open Market Committee (FOMC) has signaled the level of reserves is near the longer-run level it believes is efficient and effective to use in implementing monetary policy. The much higher level of reserves today primarily reflects banks’ demand for reserves in the face of new liquidity regulations.
The Treasury General Account has also jumped in size. In 2015, the Treasury put a new policy in place to hold enough cash in its account to meet one week’s worth of payments, with a $150 billion minimum level. This new policy has not only boosted the size of the Treasury’s account but has made it fluctuate week to week as the size reflects the upcoming week’s payment schedule.
Going forward, the size of the Fed’s balance sheet will continue to be large, reflecting market demand for its liabilities.
Taken together—with currency growth continuing at its robust 6% pace—the overall balance sheet could possibly expand as a share of nominal GDP. For some perspective, the Fed’s balance sheet was 6% of nominal GDP in 2006. At its peak in 2014, it stood at 25% of nominal GDP. Today, the Fed’s balance sheet stands a bit under 20% of nominal GDP.
Overall, as St. Louis Fed President James Bullard recently said, “The Fed’s balance sheet cannot return to its pre-crisis level because of developments in currency demand, the Treasury’s General Account and reserve demand driven by Dodd-Frank regulatory requirements.”Bullard, James. “A Successful Normalization, With Challenges Ahead.” Presentation at the Community Development Foundation of Tupelo in Mississippi, April 11, 2019.
All of these changes are triggered by market-driven forces:
Without structural changes, these Fed liabilities will remain sizable and most likely grow over time, resulting in the Fed’s balance sheet remaining bigger than its precrisis level and trending larger over time.
1 Securities holdings peaked at $4.2 trillion immediately after the end of the third large-scale asset purchase program in 2014 and remained at this size as the FOMC reinvested maturing and prepaying securities through October 2017. In addition, the composition of the Fed’s securities holdings has changed vastly, moving to a portfolio with about $1.6 trillion in mortgage-backed securities holdings today.
2 The February 2019 Monetary Policy Report discussed the role of various liabilities in determining the size of the Fed's balance sheet.
3 There are structural changes that could possibly reduce banks’ demand for reserves, such as the Fed creating a standing repo facility that would allow banks to be confident that they could convert Treasury securities into reserves if needed. For thoughts on a standing repo facility, see "Why the Fed Should Create a Standing Repo Facility" and "The Fed and a Standing Repo Facility: A Follow-Up."
4 Bullard, James. “A Successful Normalization, With Challenges Ahead.” Presentation at the Community Development Foundation of Tupelo in Mississippi, April 11, 2019.