Analysis of Federal Reserve's Balance Sheet: Economics Assignment

This assignment analyzes the Federal Reserve's actions regarding its balance sheet and the implications for the financial market. The Federal Reserve aimed to reduce the money supply by increasing reserve requirements, leading to a liquidity crunch and affecting the repo rate. The report discusses the challenges faced by the Federal Reserve, including the possibility of expanding the balance sheet or selling government securities to manage the money supply and address the shortage in the repo market. The analysis also references studies suggesting an optimal reserve level. The report highlights the pressures on the Fed and the difficulties in explaining the complex situation in the financial market, especially given the criticism from the White House. This assignment is a comprehensive overview of the Fed's monetary policies and their impacts on the economy.

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ECONOMICS ASSIGNMENT

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Summary
The article is regarding one of the targets of the Federal reserve of the USA which is to shrink
the balance sheet. For this purpose the Federal Reserve planned to reduce the money supply
by increasing the reserve requirements of the banks. This resulted in liquidity crunch in the
financial system and the repo rate suffered (Rossi et al. 520). The Fed had shrunk the balance
sheet so much that it had to intervene in the supply and demand of the market to carryout
open market operation in order to deal with the shortage. Therefore a complex problem has
arisen for the Federal Reserve where they have one of the options to expand the balance sheet
again, which is against the current goals of the central bank. Other than that, the central bank
can also sell the government securities in the market so that money supply is increased and
shortage in the repo market is managed. In the meantime it was found out from the studies
that Fed could easily reduce the reserve to 1 trillion USD for the optimal operation of the
financial market (Flannery et al. 13). The tightness in the repo market also had started to have
its repercussions in other parts of the financial market. Therefore, Fed is under a lot of
pressure at the moment especially because of the fact that they had been under attack from
the white house. Thus, explaining this complex situation in the financial market will be tough
for Fed in the coming months.

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Reference
Rossi, Barbara, and Tatevik Sekhposyan. "Forecast rationality tests in the presence of
instabilities, with applications to Federal Reserve and survey forecasts." Journal of Applied
Econometrics 31.3 (2016): 507-532.
Flannery, Mark, Beverly Hirtle, and Anna Kovner. "Evaluating the information in the federal
reserve stress tests." Journal of Financial Intermediation 29 (2019): 1-18.