All of a sudden, the Federal Reserve is considering increasing its balance sheet again.
Remember back in September? QE was on “autopilot.” Then we got the “Powell Pause” and suddenly, the talk was that balance sheet reduction could be winding down. Powell confirmed that was the case just a couple of weeks ago when he told a congressional panel the central bank would be in a position to “to stop runoff later this year.”
Peter Schiff has been saying the Powell Pause wasn’t going to be enough – that the next step would be interest rate cuts and the launch of another round of quantitative easing. Well, on Wednesday (March 6) the Federal Reserve Bank of Kansas City released a paper that indicates the central bank is already considering when to begin building up its balance sheet again, this according to Reuters.
Analysts and traders worry that a shrinking Fed balance sheet is making it expensive for banks to finance loans and trading positions, restricting their lending to companies and consumers.”
The Fed began the balance sheet roll-off in October 2017. At that point, it had grown to $4.5 trillion after three rounds of quantitative easing in response to the Great Recession.
When Ben Bernanke launched QE, he insisted the Fed was not monetizing debt. He said the difference between debt monetization and the Fed’s policy was that the central bank was not providing a permanent source of financing. He said the Treasurys would only remain on the Fed’s balance sheet temporarily. He assured Congress that once the crisis was over, the Federal Reserve would sell the bonds it bought during the emergency.
The issue, according to the Kansas City Fed paper, is that the central may need to hold a higher level of bank reserves “to properly implement monetary policy.”
Bank Reserves make up a big chunk of the Fed’s balance sheet and they have been shrinking rapidly with quantitative tightening.
Kansas City Fed Senior Economist A. Lee Smith wrote that the Fed may need to hold as much as $1.5 trillion in bank reserves on its balance sheet. According to Reuters, that would be a relatively small decline from less than $1.7 trillion now, implying as little as a few more months of reductions.
Smith has been concerned about the impact of rising interest rates on the economy. According to Reuters, last month, he wrote that the shrinkage of the US balance sheet has played a significant role in exerting upward pressure on borrowing costs.
Rising in borrowing costs are not good news in an economy built on debt.
Of course, this is just one estimate by one Fed economist. But the fact that the central bankers are already floating trial balloons about increasing the balance sheet indicates that there are concerns about the effect of tightening on the economy and it gives credence to what Peter has been saying.