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Deborah Leonard, Antoine Martin, and Jennifer Wolgemuth
An earlier post on how the Fed changes the size of its balance sheet prompted several questions from readers about the Federal Reserve’s accounting of asset purchases and the payment of principal by the Treasury on Treasury securities owned by the Fed. In this post, we provide a more detailed explanation of the accounting rules that govern these transactions.
Personal bankruptcy is surprisingly common in the United States. Almost 15 percent of the U.S. population has filed for bankruptcy sometime over the past twenty-five years, based on my calculations using the New York Fed Consumer Credit Panel/Equifax (CCP). In 2015, roughly 800,000 debtors filed for bankruptcy, according to court records, representing 0.64 percent of U.S. households. One of the consequences for filers is a mark on their credit report—a bankruptcy “flag”—which indicates that the consumer has filed for bankruptcy.
China lends to the rest of the world because it saves much more than it needs to fund its high level of physical investment spending. For years, the public sector accounted for this lending through the Chinese central bank’s purchase of foreign assets, but this changed in 2015. The country still had substantial net financial outflows, but unlike in previous years, more private money was pouring out of China than was flowing in. This shift in private sector behavior forced the central bank to sell foreign assets so that the sum of net private and public outflows would equal the saving surplus at prevailing exchange rates. Explanations for this turnaround by private investors include lower returns on domestic investment spending and a less optimistic outlook for China’s currency.
Euro area sovereign bond yields fell to record lows and the euro weakened after the European Central Bank (ECB) dramatically expanded its asset purchase program in early 2015. Some analysts predicted massive financial outflows spilling out of the euro area and affecting global markets as investors sought higher yields abroad. These arguments ignore balance of payments accounting, which requires any financial outflow from the euro area to be matched by a similar-sized inflow, absent a quick and substantial current account improvement. The focus on cross-border financial flows also is misguided since, according to asset pricing principles, the euro and global asset prices can move without any change in financial outflows.
The rise in oil prices from near $30 per barrel in 2000 to around $110 per barrel in mid-2014 was a dramatic reallocation of global income to oil producers. So what did oil producers do with this bounty? Trade data show that they spent about half of the increase in total export revenues on imports and the other half to buy foreign assets. The drop in oil prices will unwind this process. Oil-importing countries will gain from lower oil bills, but they will also see a decline in their exports to oil-producing countries and in purchases of their assets by investors in these countries. Indeed, one can make the case that the drop in oil prices, by itself, is putting upward pressure on interest rates as income shifts away from countries that have had a relatively high propensity to save.
The Bank of Japan announced an open-ended asset
purchase program in January 2013 and an unexpectedly ramped-up version of the
program was implemented in early April. Market
commentary at that time suggested that flooding the economy with liquidity
would lead to a “wall of money” flowing out of Japan in search of higher yields,
affecting asset prices worldwide. So far, however, Japan’s wall of money remains missing in action, with no pickup in
Japanese foreign investment since the April policy shift. Why is this? Here we
explain that while economic theory does not offer clear guidance on how
financial outflows might respond to the injection of cash from central bank
asset purchases, it does point to an important constraint on the potential size. In particular, monetary expansion will
not cause a surge in financial outflows unless it also induces a similar surge
in capital flowing into the country.
in the euro area periphery such as Greece, Italy, Portugal, and Spain saw
large-scale capital flight in 2011 and the first half of 2012. While events
unfolded much like a balance of payments crisis, the contraction in domestic
credit was less severe than would ordinarily be caused by capital flight of
this scale. Why was that? An important reason is that much of the capital
flight was financed by credits to deficit countries’ central banks, with those
credits extended collectively by other central banks in the euro area. This balance of payments financing was
paired with policies to supply liquidity to periphery commercial banks. Absent
these twin lifelines,
periphery countries would have had to endure even steeper recessions from the
sudden withdrawal of foreign capital.
deficits in euro area periphery countries have now largely disappeared. This
represents a substantial adjustment. Only two years ago, deficits stood at nearly
10 percent of GDP in Greece and Portugal and 5 percent in Spain and Italy (see
chart below). This sharp narrowing means that spending has been brought in line
with income, largely righting an imbalance that had left these countries
dependent on heavy foreign borrowing. However, adjustment has come at a sizable
cost to growth, with lower domestic spending only partly offset by higher
export sales. Downward pressure on domestic spending should abate now that the
periphery countries have been weaned from foreign borrowing. The risk, though,
is that foreign creditors might demand that the countries pay down (rather than
merely service) accumulated external debts, forcing them to reduce spending
Foreign investors placed roughly $1.0 trillion in U.S. assets in 2011, pushing
the total value of their claims on the United States to $20.6 trillion. Over
the same period, U.S. investors placed $0.5 trillion abroad, bringing total
U.S. holdings of foreign assets to $16.4 trillion. One might expect that the
large gap of -$4.2 trillion between U.S. assets and liabilities would come with
a substantial servicing burden. Yet U.S. income receipts easily exceed payments
abroad. As we explain in this post, a key reason is that foreign investments in
the United States are weighted toward interest-bearing assets currently paying
a low rate of return while U.S. investments abroad are weighted toward multinationals' foreign operations and other corporate claims earning a much higher rate of return.
Since October 2008, the Federal Reserve has increased the size of its balance sheet by lending to financial intermediaries and purchasing assets on a large scale. While these actions have increased the amount of reserves in the U.S. banking system and therefore raised concerns about excessive bank lending and inflation, we can document an important and overlooked benefit of the high level of reserves: a significantly earlier settlement of payments on Fedwire, the Federal Reserve’s large-value payment system. Quicker settlement on Fedwire improves liquidity throughout the economy, reducing uncertainty and risk for people and firms that rely on banks. At the same time, the Fed has been extending less intraday credit, which reduces the public’s risk exposure.
Liberty Street Economics features insight and analysis from New York Fed economists working at the intersection of research and policy. Launched in 2011, the blog takes its name from the Bank’s headquarters at 33 Liberty Street in Manhattan’s Financial District.
The editors are Michael Fleming, Andrew Haughwout, Thomas Klitgaard, and Donald Morgan, all economists in the Bank’s Research Group.
The views expressed are those of the authors, and do not necessarily reflect the position of the New York Fed or the Federal Reserve System.
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