There is an increasing focus on the Fed’s recent losses on its bond portfolio, which has declined in value as interest rates have risen:
The US Treasury will see a “stunning swing,” going from receiving about $100 billion last year from the Fed to a potential annual loss rate of $80 billion by year-end, according to Amherst Pierpont Securities LLC.
Here are five perspectives on the issue:
1. The Fed is part of the federal government’s consolidated balance sheet. Thus when Treasury bond prices decline, the loss to the Fed is exactly offset by the gain to the Treasury. It’s not an issue.
2. While point #1 is true, if the Fed had not bought those bonds then the Treasury would have gained when T-bond prices plunged. Thus the Fed’s decision to buy lots of T-bonds has created a loss relative to the counterfactual world where they did not accumulate a large bond portfolio.
3. While points #2 is true, the ultimate cause of the sharp bond price decline is the recent surge in inflation. Inflation helps borrowers (such as the US Treasury). That inflation surge would not have occurred if the Fed had not purchased lots of bonds in its QE programs.
4. Point #3 is partly true, but the Fed’s large bond portfolio also reflects its decision in 2008 to begin paying interest on bank reserves (IOR). Had the Fed not made that decision, it could have operated with a smaller balance sheet, and thus would have occurred smaller losses during the recent upsurge in interest rates.
5. Point #4 is true, but it’s also true that the Fed’s large bond purchases allowed it to make extraordinarily large profits during the low interest rate era of 2009-2021. It remains to be seen whether this policy is a net negative or positive in the long run.
On balance, I oppose IOR for a variety of reasons. But I don’t believe there is any clear and straightforward way of thinking about the Fed’s recent losses. I tend to view policy issues from the perspective of “counterfactuals”. If policy X produces the best result, then a less ideal result that we actually get is the true opportunity cost of not doing policy X. I tend not to focus very much on Fed accounting profits and losses, because the macroeconomic effects of Fed policies is many orders of magnitude more important. If the Fed stops paying IOR and focuses on the policy that results in low and stable NGDP growth, then the profits and losses will become a trivial issue.
