Theoretically speaking the Federal Reserve can shrink and expand its balance sheet. In this article we will analyze, how the FED has done it in the past and especially the FED-s ability to shrink the balance sheet and to what extent in terms of percentage. The Fed’s balance sheet includes a variety of assets, including Treasury securities, mortgage-backed securities, and other assets.
When the Fed wants to shrink its balance sheet, it can sell these assets back to the market. This reduces the amount of money in circulation, which can help to prevent inflation.
The Federal Reserve’s balance sheet has gone through several periods of expansion and contraction throughout its history, with varying percentages of shrinkage during those periods. Here are some notable examples:
- 1920s: During the 1920s, the Fed’s balance sheet shrank by about 14%, reflecting a contraction in the money supply and a tightening of credit conditions in the aftermath of World War I.
- 1930s: The Great Depression of the 1930s saw the Fed’s balance sheet expand dramatically as it tried to inject liquidity into the banking system. By 1933, the Fed’s balance sheet had grown by more than 400%.
- 1950s-1960s: During the post-World War II economic boom, the Fed’s balance sheet remained relatively stable, with only modest fluctuations in size.
- 1970s-1980s: The stagflation of the 1970s and the subsequent efforts to combat inflation in the early 1980s led to significant swings in the Fed’s balance sheet. From 1975 to 1982, the balance sheet shrank by about 19%, only to rebound by more than 50% by 1985.
- 2000s-2010s: The 2008 financial crisis and subsequent recession led to an unprecedented expansion of the Fed’s balance sheet, which grew from around $800 billion in 2007 to over $4.5 trillion by 2015.
- In 2017, the Fed began a program to shrink its balance sheet by gradually reducing the amount of reinvestments it made in its holdings of Treasury securities and mortgage-backed securities. The Fed’s balance sheet shrank from a peak of $4.5 trillion in 2015 to around $3.8 trillion in early 2020, with the balance sheet shrinking by around 16%.
Then, when the COVID-19 pandemic hit in early 2020, the Federal Reserve took swift and aggressive action to support the economy and financial markets. Here’s a summary of the Fed’s response and its impact on the balance sheet:
During the COVID-19 pandemic, the Federal Reserve expanded its balance sheet significantly in order to support the economy and financial markets. Here are the approximate percentages of balance sheet expansion during this time period:
- From March 11, 2020, to March 18, 2020, the Fed’s balance sheet increased from approximately $4.24 trillion to approximately $4.67 trillion, an increase of approximately 10.1%.
- From March 18, 2020, to March 25, 2020, the Fed’s balance sheet increased from approximately $4.67 trillion to approximately $5.25 trillion, an increase of approximately 12.4%.
- From March 25, 2020, to April 1, 2020, the Fed’s balance sheet increased from approximately $5.25 trillion to approximately $6.08 trillion, an increase of approximately 15.8%.
Overall, the Fed’s balance sheet increased by over 70% from approximately $4.24 trillion on March 11, 2020, to approximately $7.29 trillion on June 10, 2020, at the height of the pandemic-related interventions. This increase was due to a range of measures implemented by the Fed, including the purchase of Treasury securities, mortgage-backed securities, and other assets, as well as the establishment of various lending facilities to support the flow of credit to households and businesses.
Then in March 2023 Banks started to fail. Only in one week several banks failed including Sillicon Valley Bank, the big banks in the Us.
At this Point the FED-s balance sheets started to expand again as it is shown in the chart below.
It seems that ability of FED to shrink the balance sheets more than 19% has not been proven from the past history. But it was proven that it can expand the balance sheets by many folds, as it happened during the 1930 Great depression where the balance sheets grew by 400% in only 3 years.
Conclusion:
The FED has the ability to expand its balance sheets exponentially but can not shrink it too much.
