Federal Reserve Watch: What Is The Fed’s Tightening Doing To The Banking System

The Federal Reserve has been tightening its monetary policy by reducing excess reserves in the banking system and decreasing its portfolio of securities. This quantitative tightening has been going on for over a year, resulting in a decline in the M2 money stock. However, despite market pressure, the Fed has not yet backed off from its policy rate of interest, and the question remains whether the Fed’s tightening is impacting the banking system and potentially generating an economic recession.

Federal Reserve Balance Sheet

The Federal Reserve has been reducing excess reserves in the banking system since March 2022. Last week, the Fed allowed money to flow into bank accounts to keep market pressure off the policy interest rate. While the Fed saw reserve balances rise again in the past two weeks, there are still no signs that its efforts at quantitative tightening are changing.

Securities Portfolio

The Fed’s securities portfolio has declined by around $700.0 billion since March 16, 2022, with very little change occurring last week. Investors had hoped for a pivot from the Fed due to market pressures, but quantitative tightening continues.

M2 Money Stock

The M2 measure of the money stock continues to decline, decreasing by 5.3 percent between April 18, 2022, and April 3, 2023. Moreover, the decline has continued for a year, raising questions about the impact on the banking system and potential economic recession.

Related Facts

• The Fed raised the policy rate of interest last week to 5.25 percent.
• The banking system experienced some trouble in early March 2023, resulting in several commercial banks failing.
• The Fed’s reduction in excess reserves began in March 2022.

Key Takeaway

The Federal Reserve’s quantitative tightening has been ongoing for over a year, with no sign of a pivot due to market pressure. However, the M2 money stock’s decline and potential impact on the banking system and economy remain a concern.

Conclusion

The Federal Reserve’s policy of quantitative tightening has been ongoing for over a year, with very little change in its securities portfolio and a significant decline in the M2 money stock. Despite market pressure, the Fed has not yet backed off from its policy interest rate, and the impact on the banking system and potential economic recession remains a question. It will be interesting to see how the Fed navigates this situation.