by Marvin Goodfriend
e21 – Economic Policies for the 21st Century
April 10, 2014
Surplus capital is employed in commercial enterprises as a reserve for contingencies such as absorbing losses or meeting expenses and dividends when earnings are low. The Fed has employed its surplus capital similarly. Prior to the 2007-09 credit turmoil, the most important contingencies were exchange rate revaluations of foreign-currency-denominated securities that the Fed held for its own account. An appreciation of the foreign exchange value of the dollar would reduce the dollar value of the Fed’s foreign-security holdings. The Fed has carried its dollar-denominated securities at historical cost. But surplus has been used to absorb any realized losses on sales of domestic securities. Yet, since the 2007-2009 credit turmoil, the Fed has expanded its balance sheet with unprecedented aggressiveness. The Fed should use its discretion over its surplus capital today to suspend transfers and build up surplus capital against the unprecedented interest rate risk on its balance sheet.