Federal Reserve Monetary Policy in the 21st Century

Abstract

In the 21st Century, the tools of monetary policy changed fundamentally with the onset of the Great Recession and the Covid-Pandemic, both of which led to significant asset expansions of the Federal Reserve to the tune of $3.5 trillion and $4.5 trillion, respectively. To prevent these unprecedented open-market purchases of securities from reaching the economy, the Federal Reserve began paying member banks interest on bank reserve balances and borrowing reserves from non-bank financial institutions at an overnight borrowing rate. These asset expansions resulted in almost record prices in financial markets so that the purchased assets had low yields. As market interest rates rose, the payments required to prevent banks and non-bank financial institutions from expanding the money supply and producing inflation exceeded Federal Reserve income. As a result, the Federal Reserve is losing $50 billion a month! The Federal Reserve is now trying to unwind the massive expansion and in the last year has reduced its securities holding by almost $900 billion. But we are still several years from the Federal Reserve returning to its asset holdings to its former share of GDP.