Quantitative austerity is not an option for high interest rates

CAntral Banker Monetary policy is being tightened almost everywhere to deal with inflation. Markets expect interest rates to rise by about one percentage point in the US and the UK, and in the eurozone by one-tenth, year-on-year. But modern central bankers have multiple levers in their hands. Many in the rich world are preparing to put about $ 12trn against quantitative easing (That), Or buying bonds, they have managed during the epidemic. On January 26, the Federal Reserve said it would end That Soon, and for the first time, it has given guidance on how it can shrink its balance sheet, a process dub quantitative hardening (QT) Reversing trillion-dollar asset purchases may seem like a powerful way to control inflation. Actually QT Would be an unreliable tool.

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Central banks begin scrutiny of interest rates as far as possible during the global financial crisis of 2007-09 That, Which was a relatively new and poorly understood tool. But when it comes time to tighten, they prefer to follow the normal path and raise interest rates, instead of taking unknown risks. QT. So they have maintained the size of their balance sheet by reinvesting money from mature bonds. The Fed stopped reinvesting and “continued” its balance sheet until the rate reached 1-1.25% in late 2017. In 2018 the Bank of England said it would start QT After hitting the rate 1.5% – a threshold does not reach it.

The Fed’s strategy seemed to work, but as its bonds matured slowly, it was slow. In the roughly two years for which it was, the central bank’s asset stock has fallen by $ 710 billion. QT This time will start from a much higher foundation. The Fed bought a lot more bonds during the epidemic: it now holds about $ 4.5trn more assets than in 2019. If the speed of the declining glacier is repeated, the next crisis will probably hit the balance-sheet before it is too compressed. .

But the thinking has changed. “The time lag between stopping purchases and starting run-offs will be shorter, and … run-offs could be faster,” Jerome Powell, chairman of the Fed, said Jan. 11. The Bank of England plans to stop reinvesting mature bond earnings when the rate reaches just 0.5%, which could happen in February. Even the European Central Bank’s balance-sheet is expected to shrink as it brings back emergency loans to banks, predicts Goldman Sachs, a bank.

Explain what the desire for speed is QT? Andrew Bailey, governor of the Bank of England, has warned of an “ratcheting up” of the bank’s presence in the bond market if it does not scale back its holdings. A committee of the House of Lords has accused the bank of having a “dangerous addiction” to buying bonds. Most central banks also face the possibility of paying interest on the reserves they have created to buy bonds as rates rise. That. They will, in effect, bear the brunt of the government’s debt-interest costs ভূমিকা a role that may become uncomfortable.

That is what some people in the central bank think QT It may allow us to fight inflation without raising interest rates as much as we need to. “I would prefer a flatter fund-rate path and more adjustments to the balance-sheet,” said Mary Daly, president of the San Francisco Fed, in January. The theory is that That Long-term bonds hold yields, so if they are reversed, they will grow, and the economy will slow down.

However, despite the huge size ThatবAnd the universal agreement that it rescued the markets in the spring of 2020 প্রমাণ proves that it has had a lasting, big impact on long-term bond yields. Theoretically, the Fed’s bond-holding compresses the term premium, a component of long-term bond yields that compensates investors for holding money for long periods of time. But, says Dario Parkins TS Lombard, a research firm, says the term premium does not seem to track the central bank’s balance sheet. Instead it closely follows the scattering of the inflation forecast, suggesting that it reflects the risk of inflation. If That There is no permanent relevance to bond yields, nor should there be QT. Ten-year Treasury yields were low, not high, towards the end of the last round QT. In other words, although the Fed has held less bonds, their prices have risen.

There is a way that the balance-sheet policy has a clear and immediate effect: it provides a signal to the investors about the possible interest rate decision of the central bankers. Bond-buying in a recession indicates that things are really bad and therefore interest rates will remain low for a long time; Slow or vice versa That Could signal that the rate is increasing. Probably the most famous market reaction to a balance-sheet announcement, the 2013 “taper tantrum” occurred primarily because traders speculated about a short-term rate hike from which Fed Chairman Ben Bernanke spoke of a slowdown plan. Speed ​​of buying bonds.

In the late 2010s, central bankers tried to mute such signals. It was common to mention the Fed QT As is happening “in the background”. As inflation rises in 2021, they have shown less discipline. Dissenters in the Bank of England’s Monetary Policy Committee voted in favor That Speculation about rate-setters in recent weeks QT It has helped traders understand that the Fed is really serious about tightening policy, which contributes to a sharp fall in asset prices. In its latest plan, the Fed says interest rates are a tool of its primary policy. But it has definitely struggled to do more QT Low rate means increase.

Imbalance and imbalance

Perhaps it’s better that investors are waking up to the Fed’s rate plan. Still pivoting for use QT And as an alternative the rate increases, as Mrs. Daly suggests, the signaling mechanism could be reversed. More QT A lower rate increase would mean, not more, so bond yields could decline. QT The source of the stimulus would be the source of the stimulus শেষ the inflation problem of a central banker, which should be the end. 3

Read more from Free Exchange, our column on economics:
Economists revise their views on robots and jobs (January 22)
Will remote work be stuck after the epidemic? (January 15)

IMF reprimands IMF over Argentina (January 8)

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This article is published under the heading “QE to QT” in the Finance and Economics section of the print edition.

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