When The Fed Finally Raises Rates – Monetary Policy

Due to the ambitious stimulus program enacted by the Fed back in 2008, Quantitative Easing (Q.E.) led to an incredible amount of liquidity in the financial markets.

When the Fed does finally decide on increasing rates, it will do so with the largest balance sheet ever amassed. As of April 30th, the Federal Reserve’s balance sheet exceeded $4.47 trillion.

Interestingly enough, the Fed’s balance sheet has actually started to decrease since its curtailment of its bond buying program in November. The balance sheet reached a height of $4.51 trillion the week ending January 14th, yet ended the month of April at $4.47 trillion.

The challenge for the Federal Reserve, now that it has concluded its QE program, is when to actually start raising short-term rates (Fed funds rate) while confronting a weak global economy, international deflationary pressures, and record low bond yields in Europe.

The Fed had been “tapering” its bond buying program since the end of 2013 when it announced a gradual alleviation of its QE3 program.

Initial quantitative easing began in late 2008 in response to the financial crisis stemming from the events of September 2008. The Fed had been holding between $700 billion and $800 billion of Treasury notes on its balance sheet before the crisis. An additional round of Q.E. was enacted in November 2010, with a final round of Q.E. (QE3) in September 2012.

Even though new purchases of Treasuries and other government securities ended in November 2014, the Fed’s enormous balance sheet will continue to provide some buoyancy to the government bond market by limiting supply and thus suppressing long-term rates.

Some economists believe that the size and inventory of the Fed’s balance sheet will actually facilitate any gradual increase in rates by the Federal Reserve when it finally does occur.

Source: Federal Reserve