The Fed’s new tools (I)

Submitted by EconWeekly

By popular demand, I improved and expanded the notes I published a couple of weeks ago about the new tools of the Federal Reserve. I have added instruments that are not in place yet but the Fed considers using. I have ended up with a very long post, so I have broken it down into two parts. The second part will come out next week.

(I thought somebody would like to use these posts as a refresher, a summary, or even class notes. Jim Hamilton has a few great posts on the subject: September 23, December 14, December 16, March 15. The New York Federal Reserve made its own pocket version. And Greg Ip wrote a rather educational piece. Enjoy.)

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The central bank has a balance sheet, as any other bank. As assets, it holds primarily securities issued by the government and loans to banks. As liabilities, it has currency (the cash in your pockets) and reserve balances. Reserves are deposits that regular banks keep at the central bank. When a bank needs currency it withdraws from its deposit, effectively turning it into notes and coins that you and I can use. As you will see in a minute, reserves are a key element in monetary policy.

This was the balance sheet of the Federal Reserve on August 15, 2007:

Federal Reserve’s balance sheet, $ millions (Aug. 15, 2007)
Assets	US government securities	789,601
	Repurchase agreements	24,000
	Reverse repurchase agreements	-31,941
	Direct loans	264
	Other assets	37,058
Liabilities	Currency in circulation	813,085
Liabilities	Reserve balances	5,897
Changes in the Fed’s balance sheet after a $1,000M open market operation
Assets	US government securities	+1,000
	Repurchase agreements	0
	Reverse repurchase agreements	0
	Direct loans	0
	Other assets	0
Liabilities	Currency in circulation	+1,000
Liabilities	Reserve balances	0
Changes in the Fed’s balance sheet after a $1,000M discount window loan
Assets	US government securities	0
	Repurchase agreements	0
	Reverse repurchase agreements	0
	Direct loans	+1,000
	Other assets	0
Liabilities	Currency in circulation	+1,000
Liabilities	Reserve balances	0
Changes in the Fed’s balance sheet after a $1,000M repurchase agreement
Assets	US government securities	0
	Repurchase agreements	+1,000
	Reverse repurchase agreements	0
	Direct loans	0
	Other assets	0
Liabilities	Currency in circulation	+1,000
Liabilities	Reserve balances	0
Changes in the Fed’s balance sheet after a $1,000M repurchase agreement, offset by an open market operation
Assets	US government securities	-1,000
	Repurchase agreements	+1,000
	Reverse repurchase agreements	0
	Direct loans	0
	Other assets	0
Liabilities	Currency in circulation	0 (-1,000 + 1,000)
Liabilities	Reserve balances	0
Changes in the Fed’s balance sheet after a $1,000M TAF loan, offset by an open market operation
Assets	US government securities	-1,000
	Repurchase agreements	0
	Reverse repurchase agreements	0
	TAF loans	+1,000
	Direct loans	0
	Other assets	0
Liabilities	Currency in circulation	0 (-1,000 + 1,000)
Liabilities	Reserve balances	0
Federal Reserve’s balance sheet, $ millions
Assets		Aug. 15, 2007	Dec. 26, 2007
	US government securities	789,601	754,612
	Repurchase agreements	24,000	42,500
	Reverse repurchase agreements	-31,941	-40,542
	Term Auction Facility loans	0	20,000
	Direct loans	264	4,535
	Other assets	37,058	52,869
Liabilities	Currency in circulation	813,085	829,193
Liabilities	Reserve balances	5,897	4,781