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The Federal Reserve’s Quasi-Fiscal Deficit
by Nicolás Cachanosky The American Institute for Economic Research
The Federal Reserve faced an unprecedented challenge in September 2022, as it began incurring losses for the first time in 107 years. These losses have put taxpayers on the hook, necessitating the need for them to indirectly cover the Fed’s financial deficits. It also risks the Fed’s credibility since its monetary policy impacts its profits and losses.
The onset of the Federal Reserve’s financial troubles can be traced back to the 2008 financial crisis and the subsequent COVID-19 pandemic. In response to these crises, the Fed purchased large quantities of long-term financial assets, including Treasury bonds and mortgage-backed securities (MBS). During this period of low-interest rates, the Fed profited from the disparity between the higher returns it received from these assets and the lower interest rates it paid to banks through mechanisms like overnight reverse repo and interest on reserves.