An environment of rising interest rates is unlikely to cause the Federal Reserve of losing money on huge holdings, Treasury and agency securities, mortgage-Central Bank report released Monday said.
The report of the Federal Reserve Bank of San Francisco addresses a topic that has not received much attention from observers of central banks. The issue is that the Fed's current sheet counts some 2.4 trillion in securities that is so far a money maker for the EDF. Indeed, the Fed, which sends back the profits of the Treasury Department, returned 80 billion dollars last year.
But it can't last forever the current era of rock-bottom interest rates. With the economy recovery and inflationary pressures which pushed higher, albeit from very low levels, the Fed will begin to tighten monetary policy, both of the European Central Bank as last week. How the Fed will tighten policy is unclear, given the wide range of tools are now available at the Central Bank, nor is there any absolute clarity on the point of a campaign to stop the aid. At this point the market participants are not yet sure whether the Fed will begin to normalize the stance of policy.
But all the same, higher short-term interest rates over time means the Fed will make less money. If an unexpected surge in inflation caused the Fed to tighten policy quite aggressively, it is likely that the Fed could start to lose money on the farm.
This could mean the Fed will have to make sure the money from the public. The fear is that this would expose the Fed lose its independence as a de-facto bailout will come with some sort of strings that could undermine — at least in the eyes of central bankers — activity of the Federal Reserve policy-making.
The Fed's potential exposure to interest rate risk derives primarily from the authority to pay interest on Bank reserves, the paper observed. This feature allows the ypermonterna on Central Bank to compensate banks reserves stationed in the Federal Reserve, largely to preserve these reserves are undermined and economy. But in an environment of rising interest rates, maintains a higher interest rate, the Fed's lower profit level.
The paper claimed that "interest rate risk appears modest, especially compared to the Fed's policy objectives of full employment and price stability."
The San Francisco Fed paper, which was authored by the Director of research, Glenn rudebusch, sees the math accordingly: last year, the Federal Reserve earned 83 billion dollars in interest income on average yield 4% which took about 2 trillion dollars in securities, against 3.1 billion dollars in costs associated with the payment of interest on reserves.
"Short-term interest rates should be increased rapidly in quite high — in the neighborhood of 7% interest expenses — for the Fed to surpass the income from interest. Such an outcome is very unlikely, "said the paper. If the Fed did suffer a loss, this could simply hand no money back to the Treasury and, in the most extreme case, future remittances also will be reduced (and recorded as a change in the deferred credit), but the Fed's capital base and financial position will remain absolutely safe. "
Rudebusch noted that accounting issues are ultimately a regional issue for the EDF. "The statutory mandate for the conduct of monetary policy is to promote maximum employment and price stability," and "economic considerations – even potentially large capital losses – are secondary."
"Regardless of income or capital costs, the Fed still has the operational capacity to raise short-term interest rates to stem inflationary pressures," wrote Economist.
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