The US Federal Reserve, like many other central banks, engaged in massive quantitative easing in the wake of the financial crisis of 2007/8. Over three rounds, QE1, QE2 and QE3, it accumulated $4.5 trillion of assets – mainly government bonds and mortgage-backed securities (see chart below: click here for a PowerPoint). But, unlike its counterparts in the UK, the eurozone and Japan, it has long ceased its programme of asset purchases.. In October 2014, it announced that QE was at an end. All that would be done in future would be to replace existing holdings of assets as they matured, keeping total holdings roughly constant.
But now this policy is set to change. The Fed is about to embark on a programme of ‘quantitative tightening’, already being dubbed ‘QT’. This involves the Fed reducing its holdings of assets, mainly government bonds and government-backed mortgage-related securities.
This, however, for the time being will not include selling its holding of bonds or mortgage-backed securities. Rather, it will simply mean not buying new assets to replace ones when they mature, or only replacing part of the them. This was discussed by the 75 participants at the joint meeting of the Federal Open Market Committee (FOMC) and Board of Governors on 14–15 March.
As the minutes put it: “Many participants emphasized that reducing the size of the balance sheet should be conducted in a passive and predictable manner.”
A more active form of QT would involve selling assets before maturity and thus reducing the size of the Fed’s balance sheet more rapidly. But either way, reducing assets would put downward pressure on the money supply and support the higher interest rates planned by the FOMC.
The question is whether there is enough liquidity elsewhere in the system and enough demand for credit, and willingness of the banking system to supply credit, to allow a sufficient growth in broad money – sufficient, that is, to support continued growth in the economy. The answer to that question depends on confidence. The Fed, not surprisingly, is keen not to damage confidence and hence prefers a gradualist approach to reducing its holdings of assets bought during the various rounds of quantitative easing.
Articles
Fed’s asset shift to pose new test of economy’s recovery, resilience Reuters, Howard Schneider and Richard Leong (6/4/17)
Federal Reserve likely to begin cutting back $4.5 trillion balance sheet this year Washington Post, Ana Swanson (5/4/17)
Why the Fed’s debate about shrinking its balance sheet really, really matters Money Observer, Russ Mould (7/4/17)
The Fed and ECB keep a cautious eye on the exit Financial Times (7/4/17)
Get ready for the Fed’s next scary policy change CBS Money Watch, Anthony Mirhaydari (5/4/17)
The Fed wants to start shrinking its $4.5 trillion balance sheet later this year Business Insider, Akin Oyedele (5/4/17)
Inside the Fed’s March Meeting: The Annotated Minutes Bloomberg, Luke Kawa, Matthew Boesler and Alex Harris (5/4/17)
QE was great for asset prices – will ‘QT’ smash them? The Financial Review (Australia), Patrick Commins (7/4/17)
Shrinking the Fed’s balance sheet Brookings, Ben Bernanke (26/1/17)
Data
Selected data Board of Governors of the Federal Reserve System
Questions
- Distinguish between active and passive QT.
- If QE is a form of expansionary monetary policy, is QT a form of contractionary monetary policy?
- Could QT take place alongside an expansion of broad money?
- What dangers lie in the Fed scaling back its holdings of government (Treasury) bonds and mortgage-backed securities?
- Why is it unlikely that the Fed will reduce its holdings of securities to pre-crisis levels?
- Why are the Bank of England, the ECB and the Bank of Japan still pursuing a policy of QE?
- What are the implications for exchange rates of QT in the USA and QE elsewhere?
- Find out data for the monetary base, for narrow money (M1) and broader money (M2) in the USA. Are narrow and/or broad money correlated with Federal Reserve asset holdings?
Following the recession of 2008/9, the UK has engaged in four rounds of quantitative easing (QE) – the process whereby the central bank increases the money supply by purchasing government bonds, and possibly other assets, on the open market from various institutions. The final round was announced in July 2012, bringing the total assets purchased to £375bn. As yet, however, there are no plans for quantitative tightening – the process of the Bank of England selling some of these assets, thereby reducing money supply.
The aim of QE has been to stimulate aggregate demand. Critics claim, however, that the effect on spending has been limited, since the money has not gone directly to consumers but rather to the institutions selling the assets, who have used much of the money to buy shares, bonds and other assets. Nevertheless, with banks having to strengthen their capital base following the financial crisis, QE has helped then to achieve this without having to make even bigger reductions in lending.
The Bank of England now reckons that the recovery is sufficiently established and there is, therefore, no need for further QE.
This is also the judgement of the Federal Reserve about the US economy, which experienced annual growth of 3.5% in the third quarter of 2014. The IMF predicts that US growth will be around 3% for the next three years.
The Fed has had three rounds of QE since the financial crisis, but in October 2014 called an end to the process. Since the start of this year, it has been gradually reducing the amount it injects each month from $85bn to $15bn. The total bond purchases over the past five years have been some $3.6tn, bringing the Fed’s balance sheet to nearly $4.5tn.
But as QE comes to an end in the USA, Japan is expanding its programme. On 31 October, the Bank of Japan announced that it would increase its asset purchases from ¥60-70tn per year to ¥80tn (£440bn). The Japanese government and central bank are determined to boost economic growth in Japan and escape the two decades of deflation and stagnation. The Tokyo stock market rose by some 8% in the week following the announcement and the yen fell by more than 5% against the dollar.
And the European Central Bank, which has not used full QE up to now, looks as if it is moving in that direction. 
In October, it began a programme of buying asset-backed securities (ABSs) and covered bonds (CBs). These are both private-sector securities: ABSs are claims against non-financial companies in the eurozone and CBs are issued by eurozone banks and other financial institutions.
It now looks as if the ECB might take the final step of purchasing government bonds. This is probably what is implied by ECB President Mario Draghi’s statement after the 6 November meeting of the ECB that the ground was being prepared for “further measures to be implemented, if needed”.
But has QE been as successful as its proponents would claim? Is it the solution now to a languishing eurozone economy? The following articles look at these questions.
Fed calls time on QE in the US – charts and analysis The Guardian, Angela Monaghan (29/10/14)
Quantitative easing: giving cash to the public would have been more effective The Guardian, Larry Elliott (29/10/14)
End of QE is whimper not bang BBC News, Robert Peston (29/10/14)
Federal Reserve ends QE The Telegraph, Katherine Rushton (29/10/14)
Bank of Japan to inject 80 trillion yen into its economy The Guardian, Angela Monaghan and Graeme Wearden (31/10/14)
Every man for himself The Economist, Buttonwood column (8/11/14)
Why Japan Surprised the World with its Quantitative Easing Announcement Townhall, Nicholas Vardy (7/11/14)
Bank of Japan QE “Treat” Is a Massive Global Trick Money Morning, Shah Gilani (31/10/14)
ECB stimulus may lack desired scale, QE an option – sources Reuters, Paul Carrel and John O’Donnell (27/10/14)
ECB door remains open to quantitative easing despite doubts over impact Reuters, Eva Taylor and Paul Taylor (9/11/14)
ECB could pump €1tn into eurozone in fresh round of quantitative easing The Guardian,
Angela Monaghan and Phillip Inman (6/11/14)
Ben Bernanke: Quantitative easing will be difficult for the ECB CNBC, Jeff Cox (5/11/14)
Not All QE Is Created Equal as U.S. Outpunches ECB-BOJ Bloomberg, Simon Kennedy (6/11/14)
A QE proposal for Europe’s crisis The Economist, Yanis Varoufakis (7/11/14)
UK, Japan and 1% inflation BBC News, Linda Yueh (12/11/14)
Greenspan Sees Turmoil Ahead As QE Market Boost Unwinds Bloomberg TV, Gillian Tett interviews Alan Greenspan (29/10/14)
Questions
- What is the transmission mechanism between central bank purchases of assets and aggregate demand?
- Under what circumstances might the effect of a given amount of QE on aggregate demand be relatively small?
- What dangers are associated with QE?
- What determines the likely effect on inflation of QE?
- What has been the effect of QE in developed countries on the economies of developing countries? Has this been desirable for the global economy?
- Have businesses benefited from QE? If so, how? If not, why not?
- What has been the effect of QE on the housing market (a) in the USA; (b) in the UK?
- Why has QE not been ‘proper’ money creation?
- What effect has QE had on credit creation? How and why has it differed between the USA and UK?
- Why did the announcement of further QE by the Bank of Japan lead to a depreciation of the yen? What effect is this depreciation likely to have?
The US Federal Reserve, like many other central banks, engaged in massive quantitative easing in the wake of the financial crisis of 2007/8. Over three rounds, QE1, QE2 and QE3, it accumulated $4.5 trillion of assets – mainly government bonds and mortgage-backed securities (see chart below: click here for a PowerPoint). But, unlike its counterparts in the UK, the eurozone and Japan, it has long ceased its programme of asset purchases.. In October 2014, it announced that QE was at an end. All that would be done in future would be to replace existing holdings of assets as they matured, keeping total holdings roughly constant.
