I hear the term ‘balance sheet reduction’ a lot in the recent days in regards to the ending of QE. Could some please explain what balance reduction means? Is it the same as balance sheet run off (which I do not know either)?
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First of all, all money in the USA is borrowed into existence. Before someone borrows the money, it literally does not exist. And when you pay it back, it does not go to the bank, it goes back into “non-existence”, with the bank only keeping the interest. Well, during recessions and other sensitive times, the Federal reserve can add money to the economy by buying “assets” with money created out of thin air. These assets include Treasury Bills, Corporate bonds, mortgages, etc. But because this money is created out of thin air, the assets are accounted for as borrowed money. So right now the Fed has about $9 trillion of assets bought in this manner. A good portion of that balance sheet assets bought under QE or quantitative easing. So to lower the balance sheet, the Fed Sells those assets and the money goes back to oblivion and comes off the Feds balance sheet. So the number gets lower. Just to give you an idea of how things have changed, before the 2008-9 financial crisis, the balance sheet was at around $1 trillion. So they have added $8 trillion to the economy since then. This is what people call “printing money”, when you hear that in the media. But of course, it’s just a metaphor, it’s really just a number in a bank account.
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