If There Was No QE, How Could There Be QT?

How big should the Fed’s balance sheet be? It’s a topic that has taken over a lot of academic discussions. Recall that before 2008 the level of bank reserves was practically nil. They didn’t play much of a role in any money market, required reserves or not (this should be a big clue). After four QE’s spaced out over many years, there are about $2 trillion of them left.

That’s down from about $2.8 trillion at the peak. Many people have thus called this quantitative tightening, or QT. But in order for that to be a valid description, the build up of reserves would have had to have been quantitative easing. That’s exactly how it was and is described, but that’s not how the world ended up (nor term premiums in the UST market, for that matter). If it wasn’t ever easing, then how could it be tightening?

Looking at it this way, the answer to the original question is, “who cares?” If the Fed’s balance sheet has accomplished very little on the way up, there isn’t really much for it to do on the way down.

But central bankers do care, for one, largely because they continue to view monetary policy as, well, central. It’s as if 2007 and everything that followed never happened. Or, to put it in Yellen’s terms, the last lost decade was entirely “transitory.” One of these days everything will go back to making sense. You’ll see.

The problem with this argument is that it doesn’t even make much sense to those advancing it. Bank reserves are central to post-crisis monetary policy because?

Just last week, the Hoover Institute at Stanford University presented a conference on currencies, capital, and central bank balances (thanks T. Tateo for flagging it). By that description alone they give away their view on the last as it pertains to the former two. Again, however, they are not really sure why. Lorie Logan, who is Senior Vice President of FRBNY’s MOMA, spoke at the conference in laying out current thinking as to QT.

MOMA is no pure academic arm, it is the Market Operations Monitoring and Analysis division at the Open Market Desk. These are the folks whose job it is to watch open market operations and figure out what’s what. Given the behavior of them over the last ten years, had MOMA been more prominently placed in the crisis events it would have been a very tough assignment. Instead, they toil in obscurity, which is a good thing when your answer to QT is some form of I don’t really know.