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Wall Street Journal Publishes Response by CMRE Director Dan Oliver

New York, NY – August 29, 2014 – In a Wall Street Journal editorial dated August 22, 2014, University of Chicago professor of finance John Cochrane argued that the size of the Federal Reserve’s balance sheet poses no danger of inflation because “[w]hen it is time to raise interest rates, the Fed will simply raise the interest it pays on reserves,” thus preventing the $2.7 trillion of excess reserves of the banking system from entering the economy.

In a letter to editor published by the Wall Street Journal on August 29, CMRE Director Dan Oliver pointed out:

The Fed has been acquiring Treasury bonds with maturities of up to 30 years. When rates eventually rise, the Fed’s income on these bonds will stay the same—for decades. But the Fed will have to increase its payments to the banks immediately to restrain the banks from injecting trillions of dollars of excess reserves into the economy.

The enormous maturity mismatch between the Federal Reserve’s assets, which are now mostly long term, and its liabilities, which are all current liabilities, promises large losses when interest rates finally rise.

Legislation dictates that the Federal Reserve transfer any net income to the U.S. Treasury Department.  On January 6, 2011, the Federal Reserve changes its own accounting principles such that any losses the bank accrues will be recorded as a negative liability to the Treasury Department.

Monetary specialists debate the effect of losses on a central bank’s balance sheet would have on the dollar, however the Federal Reserve accounts for those losses.  In an unpublished section of the letter, Oliver cited Nobel laureate Thomas Sargent’s paper The Ends of Four Big Inflations for the proposition that losses on a central bank’s balance sheet is the direct cause of currency depreciation.

The Committee for Monetary Research & Education is a non-profit, educational organization that seeks to promote greater public understanding of the nature of monetary institutions and of the central role that a healthy monetary system plays in the well-being of a free society.


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