Economists to the Federal Reserve: Be Careful

Federal Reserve

Eyes are turning to the central bank to see what the Federal Reserve plans to do next in its bond-buying stimulus — and many are concerned that budgetary risk will rise in parallel with the economy and with interest rates. While the bond-buying stimulus resulted in a record taxpayer profit of $88.4 billion in 2012 — according to Bloomberg the likelihood that the U.S. Treasury will have a shortage is increasing.

With the economy strengthening, and interest rates going up, it may seem like only good news. However, it also would mean that the value of Fed’s bond holdings will go down while its funding costs rise — a result of the central bank paying interest on the excess reserves holding for banks. According to Bloomberg, this could result in operating losses and even more criticism from those in Washington than the central bank is already dealing with.

William C. Dudley, the president of the New York Federal Reserve Bank, said last month that the central bank is facing a certain amount of uncertainty, and that the current budgetary balance does “create some budget risk.”

“They’ve done a few things to try to insulate themselves from this concern, but I suspect in the back of their minds it still haunts them. It’s not going to go away,” said Michael Feroli, the chief U.S. economist at JPMorgan Chase. “It feels like they’ve tried to convince themselves this isn’t a problem, in part because they came up with this deferred-asset way of looking at operating losses an because they switched to a no-asset sale approach. As you add up really big numbers, it does start to creep back into their thinking,” though, said Feroli.

“If the balance sheet expands further from here, the possibility of a loss becomes more and more real. It’s not dangerous yet, but it’s getting there,” insists Roberto Perli, a former Fed economist, and presently a partner at Coernstone Macro LP. Economists don’t see tapering in bond purchases to begin until March though, and they expect quantitative easing to continue for a while.

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