The Federal Reserve and its monetary policymaking counterparts worldwide have recorded enormous losses as they raised interest rates to combat inflation. Despite the sizable hemorrhaging showing up on the books, central bank chiefs have said that they do not believe that it will alter how they conduct monetary policy.
The U.S. central bank is funded from the interest earned on its securities holdings, purchased from its open market operations to influence interest rates in the debt market.
Excess earnings are transferred to the Treasury Department—these are known as remittances. Between January 2011 and September 2022, the Fed sent Washington about $1 trillion in cumulative remittances. This helped the federal government pay some of its bills and plug a small portion of the gaping budget deficit.
For 19 months, the Fed has been deep in the red, accumulating about $1 trillion in unrealized losses. The Fed has suffered exceptional operating declines because it pays interest to banks to the tune of 5.5 percent, meaning that the interest expense exceeds the interest income. When interest rates were near zero, these costs were minimal.
Until then, the Fed will avoid a fiscal catastrophe and avert panic on Wall Street because monetary authorities redefine negative liabilities as deferred assets.
“Once the Fed returns to earning a positive net income, it will pay down the value of the deferred asset until it reaches zero, at which point the Fed will resume sending remittances to the Treasury,” the regional central bank staff wrote.
“This deferred asset accumulates until the Fed sees positive net income, which should happen once interest rates on the long-duration assets it owns start exceeding the interest paid on bank reserves and reverse repo facilities.”
Fisher Investments staff likened it to “mostly imaginary red ink” since the Fed does not maintain capital requirements like commercial banks do.
Monetary Trouble in Europe
Similar monetary trends are forming across Europe.ECB officials reported losses of $1.4 billion in 2023, and the final tally could have been higher, but policymakers released about $7 billion that the organization accumulated over several years.
The entity anticipated more losses in the coming years.
However, the ECB stated that it does not believe that this will hinder “its ability to conduct effective monetary policy.”
“The financial strength of the ECB is further underlined by its capital and its substantial revaluation accounts, which together amounted to €46 billion at the end of 2023,” the ECB said in a statement.
“The loss, which followed almost two decades of substantial profits, reflects the role and necessary policy actions of the Eurosystem in fulfilling its primary mandate of maintaining price stability and has no impact on its ability to conduct effective monetary policy.”
Officials said they anticipate that the burdens will be considerable again for the current year. However, they affirmed that these holes will not affect policymaking.
“The Bundesbank’s balance sheet is sound. The Bundesbank can bear the financial burdens, as its assets are significantly in excess of its obligations,” Bundesbank head Joachim Nagel told reporters at a Feb. 23 press conference.
The Dutch central bank suffered its first loss since 1931, totaling about $500 million. Like its counterparts, the De Nederlandsche Bank (DNB) is penciling in additional losses for the coming years, and the accumulative buffers could be eliminated.
No Country for Old Yen
Japan is experiencing the same fate as others.Bond prices have been pummeled by rising yields as they trade inversely.
BOJ policymakers are not too concerned because if the bonds are held to maturity, the paper losses based on market prices will not affect actual income volumes. At the same time, economists warn that abysmal central bank finances could trigger worries across financial markets, affecting the yen and interest rates.
Fitch Ratings economists said the losses will not alter monetary policy in Tokyo, but its exposure to possible financial losses could worsen the government’s books.
In November 2023, the 10-year yield spiked to 0.965 percent, the highest level since 2012.