The US Federal Reserve and its counterparts in Europe, Japan, the UK and elsewhere have injected about $12 trillion into the financial system to combat the economic fallout from the coronavirus pandemic, buying a range of assets and, in some cases, offering long-term loans to banks in a massive wave of quantitative easing ( QE).
With high inflation a common fear, they reverse course. Analysts at Morgan Stanley recently estimated that the Fed, Bank of England, European Central Bank and Bank of Japan could see their asset portfolios shrink by $2.2 trillion in the 12 months of May – the expected peak of quantitative easing.
Estimates are tentative, and the Fed in particular could be bolder this year if, as many analysts expect, it moves from simply allowing bonds it holds to expire to actively selling some assets to speed up the balance sheet downgrade.
It’s a unique moment. The 2007-2009 global financial crisis also triggered a wave of quantitative easing, but the subsequent recovery was not strong enough or triggered inflation so high that it warranted a simultaneous monetary tightening.
Karen Dinan said during a presentation time at the Peterson Institute for International Economics, where he is a senior member.
One risk is the impact of quantitative tightening (QT) being felt in a weaker economy with high debt levels which “is causing a wave of sovereign debt crises around the world disrupting markets” and further tightening conditions in developed countries.
But adding QT to the rate hikes already underway is a risky gamble. Officials and economists know what the overall effect should be – interest rates would be higher than otherwise – but the exact outcome is uncertain.
“There is very little experience with QT. There is not much experience here and not much globally,” Bank of England Governor Andrew Bailey said in March.
The Bank of England has already allowed its balance sheet to deteriorate through passive means, and has said that it will start considering active selling of bonds once it raises the bank rate to 1.0%. Investors expect a 0.25 percentage point increase in the rate to 1% on May 5.
On the other hand, the European Central Bank pledged to halt net asset purchases later this year, while the Bank of Japan is not about to tighten, but has been slowing asset purchases.
By far the most important piece of the game, the Fed is expected to finalize its plans at its meeting in early May. The minutes of their March debate showed that policymakers had agreed to deduct up to $95 billion a month from their holdings, about $1.1 trillion annually.
