January 1, Federal Reserve’s New Plan Might Cause a Recession

Federal Reserve members are trying to decide how quickly to reduce the central bank’s portfolio — without triggering a recession.

The Federal Reserve’s asset balance is nearly $9 trillion, most of which are securitized holdings of government debt and mortgages. CNBC reports that most of the Fed’s holdings were purchased to calm investors during the subprime mortgage crisis in 2008 and 2020′s pandemic.

“What’s happened is the balance sheet has become more of a tool of policy.” said Roger Ferguson, former vice chairman of the Federal Reserve Board of Governors. “The Federal Reserve is using its balance sheet to drive better outcomes in history.”

Historically, the central bank has used its lending power as a last resort to add liquidity to markets during distressing times. When the central bank buys bonds, it can push investors toward riskier assets. The Fed’s policies have boosted U.S. equities despite tough economic conditions for small businesses and average workers.

“If they apply too much grease too frequently, there are concerns that the overall machinery becomes risk-seeking and fragile in alternative ways,” said Kathryn Judge, a professor at Columbia Law.

Experts say that the Fed’s choice to raise interest rates in 2022 then quickly reduce the balance sheet could trigger a recession as riskier assets are repriced.

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The Federal Reserve is shrinking its $9 trillion bond program. Here’s what that means for your portfolio