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The Federal Reserve begins shrinking its $8.9 trillion balance sheet to combat sky-high inflation

The US economy may be heading for a recession, the economist warns: "100% odds" of a global slowdown

The Federal Reserve It is preparing to begin shrinking its $8.9 trillion balance sheet, using one of its lesser-known tools as it seeks to tame the hottest inflation in a generation.

In a plan outlined at the US central bank meeting in May, policymakers said they would begin winding down the balance sheet on June 1 at an initial aggregate monthly pace of $47.5 billion, a move that will further tighten credit to US households. They will increase the runoff rate to $95 billion by September, putting the Fed on track to reduce its balance sheet by about $3 trillion over the next three years.

High inflation may be ‘painfully slow’ to fall

The size of the Federal Reserve’s balance sheet, which is mostly made up of the bonds and other assets it has purchased, has nearly doubled during the pandemic as the Fed has bought mortgage-backed securities and other Treasuries in order to keep borrowing cheap.

A man wearing a mask walks in front of the US Federal Reserve building in Washington, DC, United States, on April 29, 2020. (Xinhua/Liu Jie via Getty Images)/Getty Images

Policy makers say portfolio run-off will work in tandem with higher interest rates to bring down prices by slowing growth and tightening credit. The Fed voted to raise rates by half a basis point in May and all promised that increases of similar size are on the table at the upcoming policy meetings in June and July. While it is unclear how effective the balance sheet shrinkage will be in fighting inflation, policymakers have indicated they are optimistic that it will bring down prices.

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“Although the estimates are highly uncertain, using a variety of models and assumptions, the overall balance sheet reduction is estimated to be the equivalent of a 25 basis point rate hike,” Fed Governor Christopher Waller said Monday during a speech.

The question now is whether the Fed can manage to engineer the elusive soft landing – the good point between curbing demand to cool inflation without pushing the economy into deflation. Higher interest rates tend to create higher rates on consumer and business loans, which slows the economy by forcing employers to cut back on spending.

Federal Reserve Chairman Jerome Powell Inflation

In this Jan. 29, 2020, file photo of Federal Reserve Chairman Jerome Powell pauses during a press conference in Washington. (AP Photo/Manuel Balce Ceneta, File/AP Newsroom)

Federal Reserve Chairman Jerome Powell He acknowledged that there could be some “pain associated with” lowering inflation and curbing demand, but he opposed the idea of ​​an impending recession, identifying the labor market and strong consumer spending as bright spots in the economy. However, he cautioned, a soft landing is not guaranteed.

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“It’s going to be a tough job, and it’s gotten even more difficult in the past couple of months because of global events,” Powell said Wednesday during a live event in the Wall Street Journal, referring to the Ukraine war and the COVID lockdown in China.

But he added, “There are a number of reasonable paths to getting a soft landing or a soft landing. Our job is not to block the odds, but rather to try to make it happen.”

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