QE exit [here we go again]

One memory of my final years at the Bank of England is that every two or three months we were commissioned new pieces of work on QE exit strategies, each time prompting ‘here we go again’ thoughts as the staff machine dutifully ground into action, only for events to overtake the writing, making exit an ever more distant event.

Writing this quick blog, prompted by questions from a journalist, risks jarring with the Zeitgeist in a similar way.

But it’s conceivable that the issue surfaces again with the heating up of the debate about when the Fed might tighten, itself fuelled by the increasing evidence that the recovery in the US, at least, is secure. That debate has not really questioned when the Fed will exit from quantitative easing and sell its stock of government and agency debt. Rightly so. This is an issue for later, for a number of reasons.

The Fed will be anxious about active selling after the ‘taper tantrum’. Sovereign debt markets, although clearing at historically high prices (low yields) may (may) be vulnerable to a sudden correction, volatility perhaps heightened by the ongoing negotiations in Europe between the Eurogroup and Greece.

The Fed will want reverse-QE asset sales to be part of an orderly, ongoing plan, to minimise the risk of an unwanted spike in yields, and to ease coordination with the issuance plans of the US Treasury. To maximise the chance that this is possible, it is best to wait until there is no chance that QE would have to be reversed. That means waiting until interest rates have lifted clear enough of the zero bound that this conventional instrument could bear the burden of loosening again, if that became necessary.

Another reason why the Fed can take its time is that the fears of the inflationistas have not been born out. There are two groups in this camp.

First, there are the inflation hawks that were so heavily and rightly criticised by Krugman and others. These individuals seemed to reject entirely the economics of standard monetary models at the zero bound. Their view seemed to get little traction in policy circles directly, but it may have been part of the calculation that ultimately limited the scale of asset purchases.

The second camp of inflationistas were the more sensible observers who might have placed a small probability on the worry [or is it the hope] that large balance sheet expansion might have sparked runaway inflation. This was a concern for some on the FOMC and the UK’s MPC. Such a worry would have stressed the incompleteness of our monetary macro models, and, even within them, the possibility of expectations-induced inflation scares. At any rate, as each month passed without such a scare, such a sensible observer would have been steadily revising down the probability that there would be one.

Given that, there need be no undignified rush to get shot of these purchases from the central bank balance sheet.

Conspiracists might worry that fiscal calculations would prevail to lead to exactly that, following the logic that central bankers will want to sell while the price is high. I’m more inclined to take policymakers’ word for it. And that has stressed the primacy of ensuring that sales are consistent with the monetary policy goals of the central bank.

And note that in the UK, the BoE never really took QE purchases onto its own balance sheet. This, at the insistence of former Governor Mervyn King, was indemnified from fluctuations caused by that of the Asset Purchase Facility, the Special Purpose Vehicle established to hold the assets.

A more plausible line of thought is that the FOMC might think itself pressured to scale back its balance sheet to placate the #AudittheFed movement led by Ron and Rand Paul, and supported in spirit by John Taylor. That movement – and Taylor in particular – sees very low interest rates and unconventional monetary policy as damaging and discretionary.  Some seem to see these policies – perplexingly – as an intrusion into the workings of a capitalist economy.

However, my guess is that to the extent that concerns about this pressure enter the calculation at all, scaling back prematurely for these reasons would not be the outcome.

First, it might be reasonable to conclude – especially since US political discourse has branded Yellen an overtly political appointment – that there is nothing that could be done to head off this anti-Fed movement.

Second, it would also be reasonable to think that the Fed would think that executing sales as best it could for monetary and financial stability purposes would be the thing most likely to drain support from the antiFed campaign.

 

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