During the pandemic, the government responded quickly with massive government spending and by lowering interest rates. Ignored by the public, a massive third response from the Federal Reserve was happening: the Federal Reserve’s bond buyback program, also known as quantitative easing.

The Federal Reserve started to buy $120 billion in bonds every month. The goal is to stimulate the economy by increasing the supply of money in the economy and lowering interest rates. 

Few people talk or even know about the extent of these changes.

The buyback program begins with The Federal Reserve announcing its intention to purchase a specific amount of assets from banks and financial institutions. 

The banks and financial institutions then sell their assets, such as government bonds or mortgage-backed securities, to the Federal Reserve in exchange for cash. The Federal Reserve pays for these assets with newly created money, effectively increasing the money supply in the economy.

The Federal Reserve can continue to purchase assets until it reaches its target amount or until it determines that the economy no longer requires additional stimulus. The tool began as a response to the financial crisis of 2007. 

These changes included a considerable increase in the size of the Federal Reserve. In 2007, the Fed’s balance sheet was 5% of GDP; today, it is more than 30%.

Even though this is a familiar tool for the Fed, the program was never used to this level pre-pandemic. Buying $120 billion in bonds monthly, the Fed’s balance sheet rose 40% to over $9 trillion early in 2022.

We’ve been reducing the balance sheet as of the summer of 2022. It’s been the steepest balance sheet decline since the early 1930s. A declining balance sheet restricts economic activity and lowers inflation.

The Fed’s bond buyback program is problematic because it restricts growth when the Fed eventually sells or lets the bonds mature. If sold, they are now sold at a loss because bonds decrease in value when similar bonds offer higher interest rates, just like many of the highly leveraged banks that went belly up this year in 2023.

The bonds on their balance sheet are worth less today than when they bought them. Interest rates have skyrocketed. The Fed Funds rate, which targeted 0% during COVID, has now grown to 5%. 

Lowering the Federal Reserve’s balance sheet will be painful, just like increasing interest rates causes discomfort for many. But doing so is healthy and necessary for our economy to return to a healthy growth position.

If we keep this policy, there will be significant future inflation and currency devaluation consequences. This buyback policy’s main objective is to increase the money supply in the financial system.

Economics 101 states that costs will increase when the money supply outpaces goods. Unsurprisingly, we started seeing inflation on top of a restricted supply chain and federal stimulus checks.

This program is a dangerous tool that must be used more responsibly. For most, the focus is on inflation and the Fed funds rate. This program has vast implications and effects on our economy. Educate yourself and those around you. 

Talk to your leader in Congress and let them know that being financially responsible is a serious issue.

Noah Schwab is a certified financial planner with Stewardship Concepts Financial Services LLC. He can be reached at 509.443.0845.