Quantitative Easing

Is aggressive tightening a major policy mistake? – The New Indian Express

Express press service

Global monetary policy authorities appear to be on the verge of making a “major policy mistake”.

No, we are not referring to their grossly ignored inflationary threat or the aggressive rate hikes that are driving us into a global recession.

This is the ongoing quantitative tightening (QT) exercise, where global central banks are withdrawing the excess money they have printed over the past two years. The problem is that such activity on a global scale is happening for the first time and no one has a clue how it will end up.

For their part, policymakers are giving firm assurances of a painless normalization of liquidity, but those same authorities first printed money without considering its inflationary impact and then dismissed the price hike as temporary. , only to be wrong on both counts. Their latest plea of ​​low disruption QT is viewed with disbelief and the possibility of them being right or wrong is evenly matched simply because the theoretical or practical evidence is rather limited.

In the wake of the Covid-19 pandemic, central banks embarked on a blitz of bond buying, increasing the global stock of reserves by 25%. The 10 largest economies added $23 trillion, of which the US Federal Reserve’s balance sheet alone doubled to $9 trillion.

By buying long-term bonds, central banks have taken on the interest rate risk. How? Long-term bonds have fixed rates, while interest on reserves (money that banks place with central banks) changes with the policy rate. During a rate hike cycle, central banks end up paying more than they earn. This is also new ground for monetary authorities, as until a decade ago their primary responsibility was currency, on which they paid no interest, earned income and rarely incurred losses. But that is about to change and if balance sheet contraction is delayed, losses are certain.

How did they end up here? Traditionally, central banks cut short-term rates to stimulate growth during downturns. But during the global financial crisis of 2008-09, when things looked up despite freezing rates at zero, the Fed introduced quantitative easing (QE) by buying long-term bonds by printing money. A decade later, when Covid-19 hit, QE became a universal crisis toolkit, though its effects were still being debated. But all that excess money has to go, and the reverse action is called QT, where central banks sell bonds and normalize their balance sheets.

But QT and QE are not similar. For example, EQ is deployed quickly, but its rollback is gradual, which in itself is a problem. According to CrossBorder Capital, monetary policy makers are on the cusp of a “major policy error to come” underestimating the impact of excessive QT as governments have to pay higher rates to offload the debt. The fallout is less understood given that its creator – the Fed – has only attempted QT once before! And as Fed Chairman Jerome Powell himself alluded to, its effects are “uncertain.”

The Fed will likely dump $4 trillion in about two years, and it is assumed that such a move will reduce the stock of global reserves by 5% and reduce inflation by 2%. But Barings Investments argues there is no academic work to prove it and instead thinks the risk of a major policy error by the Fed could be on the way.

Meanwhile, India is once again in the clear. The RBI’s balance sheet rose by an unprecedented Rs 12 lakh crore in the FY20 pandemic year and Governor Shaktikanta Das, who started cutting the balance sheet last October, ended the financial year. The system’s liquidity is currently in deficit, which is increasing overnight cash rates, but analysts say this is a transitory situation due to early tax outflows and will soon be reversed. That said, RBI’s vigilance on liquidity will be closely watched during the bi-weekly policy review next Friday.

Global monetary policy authorities appear to be on the verge of making a “major policy mistake”. No, we are not referring to their grossly ignored inflationary threat or the aggressive rate hikes that are driving us into a global recession. This is the ongoing quantitative tightening (QT) exercise, where global central banks are withdrawing the excess money they have printed over the past two years. The problem is that such activity on a global scale is happening for the first time and no one has a clue how it will end up. For their part, policymakers are giving firm assurances of a painless normalization of liquidity, but those same authorities first printed money without considering its inflationary impact and then dismissed the price hike as temporary. , only to be wrong on both counts. Their latest plea of ​​low disruption QT is viewed with disbelief and the possibility of them being right or wrong is evenly matched simply because the theoretical or practical evidence is rather limited. In the wake of the Covid-19 pandemic, central banks embarked on a blitz of bond buying, increasing the global stock of reserves by 25%. The 10 largest economies added $23 trillion, of which the US Federal Reserve’s balance sheet alone doubled to $9 trillion. By buying long-term bonds, central banks have taken on the interest rate risk. How? Long-term bonds have fixed rates, while interest on reserves (money that banks place with central banks) changes with the policy rate. During a rate hike cycle, central banks end up paying more than they earn. This is also new ground for monetary authorities, as until a decade ago their primary responsibility was currency, on which they paid no interest, earned income and rarely incurred losses. But that is about to change and if balance sheet contraction is delayed, losses are certain. How did they end up here? Traditionally, central banks cut short-term rates to stimulate growth during downturns. But during the global financial crisis of 2008-09, when things looked up despite freezing rates at zero, the Fed introduced quantitative easing (QE) by buying long-term bonds by printing money. A decade later, when Covid-19 hit, QE became a universal crisis toolkit, though its effects were still being debated. But all that excess money has to go, and the reverse action is called QT, where central banks sell bonds and normalize their balance sheets. But QT and QE are not similar. For example, EQ is deployed quickly, but its rollback is gradual, which in itself is a problem. According to CrossBorder Capital, monetary policy makers are on the cusp of a “major policy error to come” underestimating the impact of excessive QT as governments have to pay higher rates to offload the debt. The fallout is less understood given that its creator – the Fed – has only attempted QT once before! And as Fed Chairman Jerome Powell himself alluded to, its effects are “uncertain.” The Fed will likely dump $4 trillion in about two years, and it is assumed that such a move will reduce the stock of global reserves by 5% and reduce inflation by 2%. But Barings Investments argues there is no academic work to prove it and instead thinks the risk of a major policy error by the Fed could be on the way. Meanwhile, India is once again in the clear. The RBI’s balance sheet rose by an unprecedented Rs 12 lakh crore in the FY20 pandemic year and Governor Shaktikanta Das, who started cutting the balance sheet last October, ended the financial year. The system’s liquidity is currently in deficit, which is increasing overnight cash rates, but analysts say this is a transitory situation due to early tax outflows and will soon be reversed. That said, RBI’s vigilance on liquidity will be closely watched during the bi-weekly policy review next Friday.