Confidence Interval Projections of the Federal Reserve Balance Sheet and Income

Abstract

In response to the financial crisis of 2008 and the subsequent recession, the Federal Reserve employed large-scale asset purchases (LSAPs) and a maturity extension program (MEP) with the purpose of reducing longer-term interest rates, and thereby promoting more accommodative financial conditions at a time when the conventional monetary policy tool, the federal funds rate, was at its effective lower bound. In this note, we presented the implications for the Federal Reserve's balance sheet and income arising from a range of future potential macroeconomic outcomes.

Understanding the demand for currency at home and abroad

“…As a result, in this scenario currency demand is somewhat lower than staff projections from the Fed's Board of Governors that assume currency will grow proportionately to GDP. 10 But other outcomes are possible. As figure 1 shows, the ratio of currency to U.S. GDP has grown steadily over time.…”

Fiscal Implications of the Federal Reserve’s Balance Sheet Normalization

“…As a result, the volatility of remittances will generally increase with the duration of the purchased assets. Existing research has generally painted a benign picture of the Federal Reserve's net income in future years under baseline projections for the evolution of the balance sheet (e.g., Hall and Reis, 2015;Greenlaw et al, 2013;Carpenter et al, 2015;Christensen et al, 2015, Ferris et al, 2017, as they suggest that the likelihood of recording a sizable and long-lasting deferred asset is quite small. Section 3.2 presents our own simulations of Federal Reserve income using the FRB/US model under various scenarios for the future size of the balance sheet.…”

“…35 In the FRB/US model, the IOER is tightly linked to the federal funds rate (FFR), which is determined by an inertial Taylor (1999) rule and thus increases in response to a stronger economy and/or higher inflation. The paths for the IOER and FFR, along with the level of the term premium (lower right panel), play an 33 Our methodology for producing stochastic simulations is the same as that described in the blog post by Ferris et al (2017) which, in turn, follows Brayton et al (2014). The set of financial variables includes the federal funds rate, the 5-year, 10-year, and 30-year Treasury bond rates, and the interest rate on conventional 30-year mortgages (expressed as effective annual yield).…”

Fiscal Implications of the Federal Reserve's Balance Sheet Normalization

“…Existing research has generally painted a benign picture of the Federal Reserve's net income in future years under baseline projections for the evolution of the balance sheet (e.g., Hall and Reis, 2015;Greenlaw et al, 2013;Carpenter et al, 2015;Christensen et al, 2015, Ferris et al, 2017, as they suggest that the likelihood of recording a sizable and long-lasting deferred asset is quite small. Section 3.2 presents our own simulations of Federal Reserve income using the FRB/US model under various scenarios for the future size of the balance sheet.…”

“…35 In the FRB/US model, the IOER is tightly linked to the federal funds rate (FFR), which is determined by an inertial Taylor (1999) rule and thus increases in response to a stronger economy and/or higher inflation. The paths for the IOER and FFR, along with the level of the term premium (lower right panel), play an 33 Our methodology for producing stochastic simulations is the same as that described in the blog post by Ferris et al (2017) which, in turn, follows Brayton et al (2014). The set of financial variables includes the federal funds rate, the 5-year, 10-year, and 30-year Treasury bond rates, and the interest rate on conventional 30-year mortgages (expressed as effective annual yield).…”