Libertarians became unhinged at the new “activism” of the Fed.  Of course, nobody was more upset about this than the Fed itself.  How would you like to be the last line of defense against another depression?  The Fed certainly did not ask for that job.

The next few years saw both massive and imaginative measures taken by the Fed.  However, at some point, the Fed had to be “normalized.”  In December of 2015, they raised short-term interest rates for the first time in years and then did it again without significant impact on the economy.  Yesterday, they said we should expect another increase in December of this year and several next year.  The stock market just yawned.

More importantly, they said they would begin “shrinking” their balance sheet next month by $10 billion per month, eventually rising to $50 billion.  This is significant.  During the fight against depression, the Fed became the source of funds for market liquidity and for deficit spending.  They did this by buying bonds (primarily government and mortgage bonds) and putting those bonds on their balance sheet — to the tune of almost $3 TRILLION.  Now, selling bonds by the Fed reduces liquidity, because they are paid by money from the buyers, removing that money from circulation.  Shrinking the balance sheet. by selling off the bonds it owns, could be both tricky and dangerous.

If they sold that huge quantity of bonds suddenly, the bond market would surely crash, causing interest rates to spike.  By selling the bonds slowly, the bond market should be able to absorb it.  Wall Street must have agreed, because the stock market just yawned again.

Saving the economy is not unlike buying a house, which can be done relatively quickly but then take a very long time to pay off.  It has been eight years since the Fed started its recovery operation and is just now starting to amortize the cost.  Be patient . . . and hope that you live long enough to see the balance sheet get back to normal.