Here is one Increase focus On the Fed’s recent losses on its bond portfolio, which has declined in value as interest rates rise:

According to Amherst Pierpont Securities LLC, U.S. Treasuries will see a “dramatic swing,” from receiving about $100 billion from the Fed last year to a potential annual loss of $80 billion by the end of the year.

Here are five perspectives on the issue:

1. The Fed is part of the consolidated balance sheet of the federal government. Thus when Treasury bond prices fall, the Fed’s losses are exactly offset by Treasury gains. It’s no problem.

2. Even if point #1 were true, if the Fed had not bought those bonds then the T-bond price would have been a Treasury gain. Thus the Fed’s decision to buy a lot of T-bonds caused losses Compared to the counterfactual world where they didn’t accumulate a large bond portfolio.

3. Even if point #2 is true, the ultimate cause of bond price declines is recent inflation. Inflation helps borrowers (eg US Treasuries). That rise in inflation would not have occurred if the Fed had not been buying so many bonds in its QE programs.

4. Point #3 is partially true, but the Fed’s large bond portfolio reflects its decision to begin paying interest on bank reserves (IOR) in 2008. If the Fed had not made that decision, it could have operated with a smaller balance sheet, and thus incurred smaller losses during the recent rise in interest rates.

5. Point #4 is true, but it is also true that the Fed’s large bond purchases allowed it to make unusually large gains during the 2009-2021 low interest rate era. Whether this policy is negative or positive in the long run remains to be seen.

On balance, I oppose the IOR for several reasons. But I don’t believe there is a clear and straightforward way to think about the Fed’s recent losses. I tend to look at policy issues from a “counterfactual” perspective. If policy X produces the optimal outcome, then a less ideal outcome we actually get is the true opportunity cost of not doing policy X. I don’t focus too much on Fed accounting gains and losses, because the macroeconomic impact of Fed policies is many orders of magnitude more important. If the Fed stops paying IOR and focuses on policies that result in low and stable NGDP growth, gains and losses will become a trivial matter.

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