University of Chicago, BUS33882: Analysis of Fed Balance Sheet Memo

This report analyzes a memo discussing the Federal Reserve's (Fed) balance sheet, focusing on the implications of its size and management for the International Monetary Fund (IMF). The memo examines the potential impacts of the Fed's decisions on its balance sheet, including shrinking it from its current size, and its effects on the IMF's ability to operate and manage its financial obligations. The analysis considers various scenarios, such as the Fed maintaining a balance sheet of $4.4 trillion versus reducing it, and the implications for the IMF's bond market activities. The report also explores different viewpoints on the optimal size of the Fed's balance sheet, considering factors like unemployment, inflation, and the need to back currency circulation, while referencing several sources and authors like Ben Bernanke, Katy Burne, John Cochrane, and Narayana Kocherlakota. The memo highlights the potential costs and benefits associated with different approaches to managing the Fed's balance sheet and its subsequent impact on the economy and financial markets.

Assignment : Memo Writing
University of Chicago
Booth School of Business
Student Name: Student ID:
Subject Name: Money, Banking, and the Financial Crisis Subject ID: BUS33882
Date Due: Professor Name:
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Dear Madam,
Federal Open Market Committee (FOMC) wants to exit from Fed’s large balance sheet for the
next few months for the purpose of current economic situation (Cochrane December 7, 2016).
Fed just has been purchasing enough securities to meet the market obligations and financial
crisis. But recently it stopped such purchases and kept its balance sheet constant. This would
eventually lead to shrinking of the size of Fed’s balance sheet that will have impact on operation
of monetary policy for the market. Fed’s market choices will be preceded by ECB along with
other central banks, who will also aim to exit from extraordinary monetary policy (Bernake
January 26,2017).
(a) IMF Board of Directors will have significant cost and benefits from this approach. In
case Fed starts to shrink the balance sheet this year prior to waiting, it will have a cost
impact on IMF. There will be no substantial benefits as Fed will no longer be purchasing
any sort of bonds or enhancing its liquidity position.
(b) (i) In case Fed keeps balance sheet at current $4.4 trillion versus reducing it by $2 trillion
as San Francisco Fed Bank President suggests, then IMF will be benefitted (Kocherlakota
May 16, 2017). IMF will be able to float more bonds for Fed which will be purchased by
it and IMF will have access to a wide range of funds.
(ii) In case Fed reserves balance sheet at $4.4 trillion compared to reducing it to pre-crisis
size that is relative to the economy of around $1.5 trillion, then IMF will be immensely
impacted. As Fed owns a huge balance sheet consisting of government bonds of $ 3
trillion, mortgage backed securities along with certain reserves. Reducing its size will
mean reducing its market related obligations. Such reduced size will allow immense
amounts of liquidity that can possibly lead to a crisis related situation (Burne May 05,
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2017). IMF will incur high costs for its bonds which would have been otherwise
purchased at rates lower.
In order to assess the ultimate size for Fed’s balance sheet various researchers have various
views. Some suggests increasing of size whereas there are many who suggests reducing of such
size. Some author suggests that Fed’s ultimately balance sheet will be around $2 trillion with
high quality bonds and other market related securities. The balance sheet figure of Fed of $2
trillion will be able to meet crisis and other issues of unemployment and inflation. It will allow
backing up of currency circulation of $500 billion in excess of its reserves. Some authors
suggests that Fed will be making a mistake in case it makes its reserves at $2 trillion as it will be
leaving its economy vulnerable. Reducing its balance sheet will make the economy similar to its
past economic crisis satiations. Shrinking its current size of balance sheet might make matters
simple but will lead to further future complexities.
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Bibliography
Bernake, Ben S. "Shrinking the Fed's balance sheet." January 26,2017.
Burne, Katy. "Fed's Williams Sees Future Balance Sheet Size Starting at $2 Trillion." Dow Jones
Newswires, May 05, 2017.
Cochrane, John. "Balance Sheet Balance." Grumpy Economist Blog, December 7, 2016.
Kocherlakota, Narayana. "The Fed Is Making a $2 Trillion Mistake." Bloomberg, May 16, 2017.
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