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We know not everyone loves central banking history quite like Alphaville loves central banking history. And we’ll forgive readers who feel they’ve had their fill of Fed happenings for the month.
But for those with the appetite, Ruth Judson and Colin Weiss, two economists working at the Fed, have dropped some cracking data plotting the history of their balance sheet back to inception in 1914.
A picture tells a thousand words, so we’ll stop here and let the chart do the talking:
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Fed balance sheet expansions have been a go-to policy response to major upheavals for over a century, including the first world war, the Great Depression, the second world war, the global financial crisis and COVID-19.
And it’s fascinating to see the role of gold over the years. As the authors note:
[G]old certificates remained the dominant asset component and Federal Reserve gold certificate holdings grew considerably in the years leading up to WWII, as gold flowed out of Europe and into the U.S. (and Treasury and the Fed chose not to sterilise most of these inflows) [issuing dollars].
[…]
Stability of the system required the relative supplies of dollars and gold to be such that the open market price of gold remained near the official price of gold. Unfortunately, conditions were such that gold steadily flowed out of the U.S. to keep the market price of gold around $35 until U.S. gold holdings were deemed insufficient to redeem dollars for gold, with official convertibility of the dollar into gold at a fixed rate ending in 1971 and other governments letting their currencies float in 1973.
Post-Bretton Woods there’s a long period during which the Fed balance sheet sort of sits things out, before all hell breaks loose with Lehman Brothers, AIG, and much of the rest of the global financial system failing or threatening to fail. Treasuries and Agency securities were purchased in size, and the volume of bank reserves increased correspondingly. It wasn’t until 2014 when the unwound begun:
Treasury and agency securities holdings were not sold, but were allowed to mature with less than full replacement. Over the five years from 2014 to 2019, the balance sheet shrank from about 25 per cent of GDP to a bit less than 20 per cent.
But COVID struck. So back to money-printer go brrrrrr. The balance sheet peaked at 37 per cent of GDP in 2021 and has been shrinking ever since.
In the four years since Fed assets and liabilities have shrunk by 14 per cent of GDP — the fastest pace of balance sheet contraction in the history of the Fed. It will be interesting to see whether Kevin Warsh, the incoming Fed chair, is able to match Powell’s pace.
Further reading:
— An oral history of the Fed’s Covid-19 crisis
— A history lesson on why we need central banks
— Was the Bank of Amsterdam the world’s first central bank?
— When the president wants a ‘low rates guy’
