Jan 29, 2022

EconExtra: All Eyes are on the Fed Balance Sheet

EconExtra is a series of posts that go beyond the textbook, relating current events and recent developments in economics to content standards, and providing resource suggestions to help you incorporate the current events into your lessons.

 

The Headlines

Omicron, inflation, supply chain issues, a potential Russia/Ukraine war, and the Federal Open Market Committee Meeting all wreaked havoc in markets this week. Pundits were wondering if the Fed would announce an interest rate hike, their primary tool in modulating the economy.  But they were also wondering if the Fed would give any indication as to when and how they will begin to reduce the size of their balance sheet, which has grown to $9 Trillion. (You can actually see the Balance Sheet here.)

If you would like, you can have students read the actual Fed press release and/or watch the Press Conference with Chairman Jerome Powell following the release (it runs 55 minutes.) But CNBC summarized the Fed’s actions well. Bottom line is that the Fed left interest rates at 0-.25% but hinted that an increase is imminent (the next opportunity being at the March meeting.) The last time the Fed raised the interest rate was in December 2018. Nothing was mentioned about the balance sheet in the press release.

 

Understanding The Issue

The balance sheet was obviously discussed in the meetings, but without settling on specific actions at this time. However, a document was released following the meeting that stated the Principles that will be followed to reduce the balance sheet. That CNBC article summarizes these principles as well. It appears that the Fed will not alter their tapering plan, that a wind-down of assets won’t begin until interest rates are raised (as conditions for one will be sufficient for the other), that the Fed will be transparent about the movements when the time comes, and that their preference will be to hold Treasuries, and not the asset-backed securities they have been buying.

 

The terms used regarding these changes to the Fed Balance Sheet are Quantitative Easing (asset purchases), and Quantitative Tightening (asset sales). A little bit of accounting is helpful in understanding and explaining what is actually going on here, and how these purchases and sales impact the availability of credit. There is a website called FedGuy.com that is a good source for help here. Specifically, here is the post explaining Quantitative Easing (QE) from September 2020, and here is the parallel post explaining Quantitative Tightening (QT) from this month.

 

Lesson Idea

1) Recreate the balance sheet entries from these articles for QT and/or QE with your class. You could do this physically by putting account T-charts of the various entities involved on the board, and hand out the entries written on cards or post-its to the students. You might color code these cards to match up both sides of each transaction. Then call students holding the cards to bring them up and place them in the correct side of the correct account, and talk through what is actually going on.

One might want to start with the QT example because this is what the Fed is expected to start doing, and also because the example given is a bit more straightforward. The QE example has many different forms depending on the parties involved. If you focus on QT for demonstration purposes, QE can be presented as the opposite.

 

2) Follow-on discussions can go a few different ways, but you would basically want to work through the impact of the actions in either/both cases on cash and credit.

  1. Why/what does this action “ease” (for QE) or “tighten” (for QT). What are the implications for the prices of other assets (stocks) during easing or tightening?
  2. Why does the Fed begin QT with modest reductions? What limits how big a reduction the Fed can make each month? What happened in September 2019 that made the Fed stop tightening? 
  3. QE has been equated to “printing money.” Under what conditions might this trigger inflation? Have those conditions been met during the pandemic, or are other factors driving current inflation?

About the Author

Beth Tallman

Beth Tallman entered the working world armed with an MBA in finance and thoroughly enjoyed her first career working in manufacturing and telecommunications, including a stint overseas. She took advantage of an involuntary separation to try teaching high school math, something she had always dreamed of doing. When fate stepped in once again, Beth jumped on the opportunity to combine her passion for numbers, money, and education to develop curriculum and teach personal finance at Oberlin College. Beth now spends her time writing on personal finance and financial education, conducts student workshops, and develops finance curricula and educational content. She is also the Treasurer of Ohio Jump$tart Coalition for Personal Financial Literacy.

Mail Icon

Subscribe to the blog

Join the more than 11,000 teachers who get the NGPF daily blog delivered to their inbox: