The Federal Reserve’s Balance Sheet and Monetary Base Determination

Balance sheet of either one of the district banks, or the aggregate of all district banks (“The Federal Reserve Bank”)

The Federal Reserve’s Balance SheetSecurities Held Federal Reserve

Discount Loans Notes

Gold Certificates Bank Deposits

SDR Certificates US Treasury

Coin Held by Fed Deposits

Float Foreign and Other

Holdings of Deposits

Foreign Currency

Physical Capital Capital Account

Federal Reserve Assets

Securities Held -- mostly T-Bills, used for open market operations

Discount Loans -- loans advanced to banks at the discount rate

Gold Certificates -- Fed converts gold obtained by US Treasury

SDR Certificates -- Fed converts Special Drawing Rights obtained in international trade.

More Fed Assets

Coin Held by the FedFloat -- cash items in the process of

collection minus deferred availability cash items (check clearing)

Holdings of Foreign Currency -- used in exchange rate intervention

Physical Capital

Federal Reserve Liabilities and Equity

Federal Reserve Notes Outstanding -- currency held by the public (C) + vault cash inside banks

Bank Deposits at the Federal Reserve -- especially helpful in check clearing

The Monetary Base and the Fed’s Balance Sheet

Consider the sum of the first two components.

(Federal Reserve Notes Outstanding) + (Bank Deposits at the Fed)

= (C + Vault Cash Inside Banks) + (Bank Deposits at the Fed)

= (C) + (Vault Cash Inside Banks +

Bank Deposits at the Fed)

= (C) + (R)

= H

The Fed’s Balance Sheet: Another RepresentationSecurities Held Currency Held

Discount Loans by the Public (C)

Gold Certificates Bank Reserves (R)

SDR Certificates US Treasury

Coin Held by Fed Deposits

Float Foreign and Other

Holdings of Deposits

Foreign Currency

Physical Capital Capital Account

Still Another RepresentationSecurities Held Monetary Base (H)

Discount Loans US Treasury

Gold Certificates Deposits

SDR Certificates Foreign and Other

Coin Held by Fed Deposits

Float

Holdings of

Foreign Currency

Physical Capital Capital Account

Other Federal Reserve Liabilities + EquityUS Treasury DepositsForeign and Other Deposits -- deposits

of some foreign governments and central banks, world organizations.

Capital Accounts (Fed Equity) -- Federal Reserve is a profit maker, but not profit maximizer, allowed an equity-asset ratio of 3%.

The Federal Reserve as a Check Clearinghouse

Example -- Suppose you get a check of $100 from your parents, who bank at Citibank (within the NY district). You deposit it in your checking account (D) at your bank, Chase, in Syracuse.

Balance Sheet Description: The Banks

Citibank

R -$100 D -$100

Chase

R +$100 D +$100

Balance Sheet Description: The Federal Reserve

Federal Reserve Bank of New York

R -$100 (Citibank)

R +$100 (Chase)

Any change in Bank Reserves is noted on the liability side of the Federal Reserve

Monetary Base Determination

Identity -- Fed’s balance sheet.

Securities Held + Discount Loans + Gold Certificates + SDR Certificates + Coin Held by the Fed + Float + Holdings of Foreign Currency + Physical Capital

= H + US Treasury Deposits + Foreign and Other Deposits + Equity

The Monetary Base Equation

Solve equation for H.

(Securities Held + Discount Loans + Gold Certificates + SDR Certificates + Coin Held by the Fed + Float + Holdings of Foreign Currency + Physical Capital)

– (US Treasury Deposits + Foreign and

Other Deposits + Equity) = H

Monetary Base -- Sources

Sources of the Monetary Base -- Items whose increase increases the monetary base.

Example -- Securities Held H

The Balance Sheet Description

Fed buys a $100 bond from Chase.

Federal Reserve

Securities +$100 R + $100

Held

H = C + R = $0 + $100 = $100

Monetary Base -- Uses

Uses of the Monetary Base -- Items whose increase decreases the monetary base.

Example --

US Treasury Deposits H

The Balance Sheet Description

The Federal Government collects $100 in taxes (people paying from their checkable deposits at Chase).

Chase

R - $100 D - $100

The Federal Reserve’s Balance Sheet

Federal Reserve

US Treasury

Deposits + $100

R - $100 (Chase)

H = C + R = $0 + -$100

= -$100

Can the Fed Reasonably Control the Monetary Base?

(Securities Held + Discount Loans + Gold Certificates + SDR Certificates + Coin Held by the Fed + Float + Holdings of Foreign Currency + Physical Capital)

– (US Treasury Deposits + Foreign and

Other Deposits + Equity) = H

Yes -- They Can Reasonably Control the Monetary BaseThe monetary base has components

both controlled by the Fed and not controlled by the Fed.

But, Securities Held is the largest component within the equation.

And, while changes in the other components may be large, they tend to be isolated and fairly predictable.

Sterilization of Undesired Changes in H

The Federal Reserve can use open market operations to offset undesired changes in the monetary base -- sterilization

Sterilization -- An Example

Suppose that the Federal Reserve wishes to sterilize the decrease in H due to tax collection.

US Treasury Deposits + $100

H -$100,

Securities Held + $100

H +$100,

Net effect: H = $0.

Application -- Exchange Market Intervention

Suppose that the Federal Reserve is concerned about an excessive downward movement of the US exchange rate. It intervenes by using its holdings of foreign currency to buy dollars (then remove the dollars from the system).

Sterilized Versus Unsterilized Intervention

Holdings of Foreign Currency H Sterilized Intervention -- Fed performs

an open market operation to offset this effect, Securities Held H

Unsterilized Intervention -- Fed does nothing, allows H to decrease.

Types of Open Market Operations

Defensive Open Market Operation -- Open market operations done to offset an undesired change in the monetary base.

Dynamic Open Market Operation -- Open market operations done to initiate monetary policy.