2
$\begingroup$

On Monday, 06 April, 2020 the Financial Times reported that the Federal Reserve balance sheet could increase to $9 trillion. This is partly due to the myriad of initiatives, some new, to protect the economy of the United States during the 2020 Coronavirus Pandemic.

A lot of online commentary is alarmist and centres on the threat of hyperinflation and many of the news articles don't inform the reader how the Federal Reserve purchases assets.. This puts the average citizen at a disadvantage when understanding the economic impact.

My question is multi-faceted (but singlular) and aiming to focus purely on the economics.

  • How does the Federal Reserve unwind the positions on their books? Do financial services have to purchase the assets back at a later date and does the Federal Reserve charge a premium for the service?
  • Can a position of this size (60% of national output) actually be unwound?

If this question is similar to the approaches of other Central Banks then please tag accordingly if appropriate.

$\endgroup$
  • $\begingroup$ This is not a new policy tool. The Fed did the same thing during the Great Recession and we had low, stable inflation throughout. There isn't a good reason to expect hyperinflation now. $\endgroup$ – 123 Apr 7 at 16:24
  • $\begingroup$ Re: "online commentary is alarmist and centres on the threat of hyperinflation". Indeed. To note just one question here (there were more): economics.stackexchange.com/questions/34656/… (I've tagged your question with QE since there's no QT tag here for now.) $\endgroup$ – Fizz Apr 7 at 17:13
  • $\begingroup$ Re: "Can a position of this size (60% of national output) actually be unwound?" The real question (if inflation is your target/worry) is not "can" but "does it have to" and "in what time frame does it have to". The BoJ has slightly over 100% of Japan's GDP on their sheet. (See my answer to the linked question for a graph/ref.) $\endgroup$ – Fizz Apr 7 at 17:20
6
$\begingroup$

The unwind depends upon what the central bank did.

  • If the central bank did a repurchase agreement (“repo”) or lent against assets for a fixed time, the agreement automatically unwinds at the term of the deal (which is short). They would need to enter into new deals to keep their balance sheet size unchanged.
  • If they bought the asset outright, it will either mature, or the central bank can sell ahead of maturity.

There are no “charging a premium” involved; the cost of the operation is embedded in the lending cost (or purchase/sales price of an asset).

There was a very large debate about unwinding central bank balance sheets in the 2010-2016 (?) period. The Fed was eventually able to slowly reduce the size of its balance sheet in the last cycle, and there is no reason to believe that this time is different. There is no sign that an “unwind” was necessary, nor are the effects of unwinding a deep concern.

| improve this answer | |
$\endgroup$
  • 1
    $\begingroup$ +1 though there is also no reason to believe this time is the same, as the liquidity/solvency issues seem to be different based on lockdown rather than overleveraging. The 2013 "temper tantrum" suggested that markets were overly sensitive to Fed behavior, and could be again. $\endgroup$ – Henry Apr 7 at 16:28
  • 1
    $\begingroup$ As an answer to "[c]an a position of this size (60% of national output) actually be unwound", "[t]he Fed was eventually able to slowly run down its balance sheet in the last cycle" is slightly misleading as they weren't able to make any serious progress: they went from around \$4.4 trillion to \$3.7 trillion (fred.stlouisfed.org/series/WALCL). $\endgroup$ – Kent Shikama Apr 7 at 16:37
  • $\begingroup$ There’s no actual evidence that “unwinding” is even necessary, nor is there much evidence it mattered. $\endgroup$ – Brian Romanchuk Apr 7 at 17:22
  • $\begingroup$ @KentShikama: I've seen economists talk (I'll add link once I find it again--it was one of the many Voxeu CEPR articles IIRC) that "this time will be different" in the sense that once people return from the lockdown en-masse [assuming that happens], there will be a spending surge, which is worrisome inflation wise. But it was "just talk" not an actual model. Found it "More circular spending with less circular production can lead to inflation." voxeu.org/article/… $\endgroup$ – Fizz Apr 7 at 17:32
  • 3
    $\begingroup$ The reason why the Fed’s balance sheet was unwound slowly was because inflation was below target. If inflation rise, there’s no issue with unwinding it faster. We also run into the issue that there is no a lot of evidence that QE had any effect on the real economy or inflation. $\endgroup$ – Brian Romanchuk Apr 7 at 18:39

Your Answer

By clicking “Post Your Answer”, you agree to our terms of service, privacy policy and cookie policy

Not the answer you're looking for? Browse other questions tagged or ask your own question.