The Federal Reserve will begin to shut down its bond buying program during the pandemic later this year, leaving the U.S. central bank with a balance sheet of more than $ 8.5 trillion before the purchases end in mid-2022 and a likely debate on what to do different next time.
The quick response may be nothing: By roughly doubling the size of its holdings of securities since the pandemic began in early 2020, the Fed has helped stabilize financial markets, used its pending purchases. to signal that it would fight the economic crisis for as long as necessary, and has now planned its liquidation without market “crises”.
Fed Chairman Jerome Powell, speaking to reporters on Wednesday after the end of a two-day policy meeting, said the central bank would start cutting its $ 120 billion in monthly asset purchases “soon “and would finish them by the middle of next year.
âHe hit his mark,â said Tom Garretson, senior portfolio strategist at RBC Wealth Management.
The biggest problem, Garretson and others noted, is that beyond the initial impact on financial markets, it is uncertain whether the Fed’s purchase of bonds, or “the Quantitative easing, “as it is called in monetary policy circles, would have been enough to offset the deep, so short-lived, recession without the massive government spending that was authorized by Congress.
Take-out? The monetary policy led by the Fed and the budgetary programs implemented by elected officials will also have to come together in future recessions.
“The dominant lesson (…) is that the tools of the Federal Reserve and other central banks are woefully insufficient to deal with a significant weakening in economic activity, and budget makers must recognize this,” said David Wilcox, former Fed chief. research division and now principal investigator at the Peterson Institute for International Economics.
The Fed’s response to the crisis and some of Washington’s budget support are now expected to decline, which could act as a drag on an economy still emerging from the pandemic, with growth expected to slow in 2022 after a healthy rebound This year.
But these programs have produced unexpected results, including increased household income and wealth and reduced poverty despite the recession.
For the Fed, the pandemic has cemented its once-‘unconventional’ purchases of US Treasury bonds and mortgage-backed securities at the heart of monetary policy, the preferred way to continue to help the economy once the market recedes. overnight interest rate benchmark of the central bank or the federal funds rate, was reduced to zero.
Other programs temporarily broadened the type of securities the Fed could buy to include municipal and corporate bonds.
In a congressional hearing Thursday, Roosevelt Institute economist Mike Konczal said this should be an integral part of Fed policy.
These efforts “have been more successful than people realize,” in limiting borrowing costs for local governments and businesses, Konczal said, and are “an unconventional monetary policy development … which is likely to stay with us “.
Other central banks have already expanded the assets they can buy beyond securities issued and guaranteed by governments.
The scale and duration of the Fed’s purchases during the pandemic upset some elected officials, while some policymakers felt the program offered little benefit in recent months.
This may argue for more flexibility in the next crisis as to how and when to end asset purchases.
The Fed’s pandemic-induced QE was closely tied to labor market performance. With the labor market recovering more slowly than the economy as a whole and inflation now a concern, “they needed a way out,” said William English, professor at the Yale School of Management and former head of the monetary affairs division of the Fed.
Quantitative easing entered the lexicon of US monetary policy in 2009 as part of then-Fed Chairman Ben Bernanke’s response to the financial crisis and recession of 2007-2009.
The Fed, unlike the European Central Bank, did not want to resort to negative interest rates to stimulate the economy, so once the âzero lower boundâ of the federal funds rate is reached, it uses the purchases of ‘bonds to further lower the cost of credit. . This encourages purchases of homes, cars, and other items that involve longer-term loans, and can also raise asset prices and contribute to wealth spending.
Its effectiveness and the risks it may present remain a subject of debate.
Fed staff and policymakers themselves have published nearly 80 articles since 2009 on the benefits, limitations and risks of QE. The general conclusion is that this helps especially at the onset of a crisis when the mere announcement of central bank support can build confidence and, over time, help anchor interest rates.
One indicator of this impact, the so-called shadow fed funds rate, is currently estimated at -1.8%, where the Fed’s target rate should be to produce current levels of bond yields.
One of the reasons it may be difficult for the Fed to deviate much from the way it did QE during the pandemic is precisely because it’s the early promise of unlimited support that seems to be the key. main advantage.
Details may differ next time. Policymakers disagree, for example, over the combination of monthly asset purchases – split between $ 80 billion in treasury securities and $ 40 billion in mortgage-backed assets – at a time when house prices are skyrocketing.
But if the pandemic has proven anything, it’s that scale matters and it’s better to predict the worst and be surprised on the upside. The pandemic looked like a long-lasting event at the level of the Great Depression in March 2020, when the US central bank lowered the federal funds rate to near zero and committed to buying assets that drove its holdings down. in securities of $ 3.8 trillion. to about $ 5.9 trillion at the end of May of the same year.
“We can all complain about the imprecision of (QE) and not knowing exactly how it works and how well it works,” said Roberto Perli, economist at Cornerstone Macro.
“But what is the alternative?” said Perli. In the next recession, “you will probably have to start over in a decent size and with the same overall makeup.” – Reuters