Federal Reserve Decides How to Do the Big Unwind: QuickTake Q&A

The Federal Reserve helped pull the U.S. economy from the brink of disaster by purchasing vast quantities of government bonds and mortgage-backed securities. That rescue, known as quantitative easing, was designed to promote economic growth by keeping long-term interest rates low, but it also pumped up the assets on the Fed’s balance sheet to an unheard-of $4.5 trillion. The Fed stopped its buying spree in 2014, but purposely refrained from paring its bloated balance sheet until it was sure the economy was good and ready. Now, that moment is approaching, with Fed Chair Janet Yellen saying on June 14 that the process could begin “relatively soon.”

At $4.5 trillion, the Fed’s balance sheet is equivalent to about a quarter of America’s annual gross domestic product. By holding down yields on Treasury securities and mortgage-backed debt, the Fed made it cheaper for the U.S. government to finance its budget deficits and for home buyers to take out a loan. It reduced costs for companies in China and other emerging markets that borrow in dollars. It also had important implications for financial markets. The Fed’s purchases made U.S. Treasury securities more expensive, thus encouraging investors to buy stocks instead. This way, the Fed has helped fuel the huge run-up in equity prices since 2009.