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In March, the Federal Reserve
should conclude the expansion of its US$ 8.8 trillion balance sheet and
then begin to implement what will likely be several interest rates hikes
this year. Still, like many other central banks that engaged in large-scale
asset purchases (LSAPs), the balance sheet remains outsized. Globally,
central bank balance sheets have ballooned to roughly US$36 trillion.
Enlarging central bank balance sheets, while important for deploying
maximum monetary policy accommodation, are simultaneously creating
financial stability risks.
These risks are plentiful. Prolonged maintenance of a large balance sheet
exposes the central bank to financial market developments that might reduce
the values of assets on the balance sheet while leaving the liabilities.
For instance, the Fed’s large exposure to US Treasury assets leaves it
vulnerable to potential sovereign debt downgrades associated with debates
about raising the government’s debt ceiling. Additionally, LSAPs could
potentially crowd out some investors from sovereign debt markets who are
unable to or would prefer not to invest in riskier assets. LSAPs can also
potentially generate inflation and depreciation of the local currency.
Finally, outsized balance sheets can also cause credibility risks if
investors do not believe that they can be paired down successfully.
For more information about financial stability risks see StraightTalk®
A Deep Dive on Risks to the Outlook. For more about Fed policy
and risks see Executive's Guide to Fed Policy and Associated Risks:
Part 2.
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