In a recent development, the Federal Reserve has ramped up its efforts to combat inflation, potentially triggering the withdrawal of trillions of dollars from the banking system.
According to a newly released paper by the Federal Reserve, the central bank is contemplating a significant reduction in the amount of cash circulating within the banking system, as highlighted in a Reuters report.
The paper indicates that bank reserve balances held at the Federal Reserve could see a substantial cut of up to 90%, plummeting from the current $6 trillion mark to as low as $600 billion. This proposed action reflects the Federal Reserve’s commitment to implementing tighter monetary policies.
Notably, in 2020, the Federal Reserve initiated an extensive securities-buying program aimed at maintaining economic stability. Through the purchase of US treasuries and mortgage-backed securities (MBS) in the open market, the Federal Reserve injected trillions of dollars into the banking system, stimulating lending and fostering economic activity.
This massive accumulation of securities propelled the Federal Reserve’s balance sheet to an unprecedented level of nearly $9 trillion by the beginning of 2022. However, with the persistent challenge of inflation faced by American consumers, the Federal Reserve has already begun unwinding its substantial bond and MBS portfolio. This strategic move seeks to alleviate excess liquidity within the banking system.
As cash reserves are reduced, banks are expected to curtail their lending activities. Consequently, this may lead to a decline in overall economic activity. However, this contraction in lending could prove advantageous for the Federal Reserve in its ongoing battle against persistent inflation, which has been a cause for concern among US consumers.
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