It is hypocritical, I suppose, to claim that Janet Yellen is irrelevant while at the same time constantly writing about the oblivious things she says. The Fed doesn’t matter but we need to obsessively focus on monetary policy anyway. Often the reasoning is upside down. By that I mean, we hope that by highlighting how little authorities know that someone somewhere will finally run with it. Step 1 on the road to recovery is changing the very idea of a central bank, and so obsessing about its missteps is part of the package.
There are other considerations, too. Though while QE, for example, achieved nothing of monetary value, it was not itself nothing. The FOMC through its Open Market Desk at FRBNY did purchase trillions in securities, and continues to this day to reinvest maturing issues. It didn’t raise the effective global “dollar” supply, but it did distort certain important mechanics.
Unwinding the Fed’s balance sheet holds the potential to do the same. And it isn’t at all one for one, meaning that in whatever way QE did things, we can’t simply assume that undoing QE will do the same things just in the opposite direction. If only it were that simple. I suspect in five and a half years’ time when the 2017 FOMC transcripts are released they will have recorded a great deal of angst on policymakers’ part.
The act of undoing a QE transaction for the government is simple enough, but what effect will it have on banks? Bank reserves are for the largest dealers a big source of liabilities. Reduce that source and something has to happen, though we don’t know what that might be. Will banks be forced to sell assets? Might they attempt to replace those reserve balances by borrowing in money markets that today are quite barren?
I suspect that is one motivation behind the Treasury Department’s mid-June proposal to change the SLR. You have to believe that the Fed and Treasury have discussed various ways to work together so as to reduce or eliminate any seriously deleterious effects on money markets (including, if I am permitted to wildly speculate, using Treasury resources to almost “sterilize” the Fed’s balance sheet unwinding in a manner not dissimilar to what those agencies used to do together in the 1920’s and 1930’s with gold). If the Treasury Secretary believes that a softer SLR could lead to unlocking trillions for money dealers, it would be quite fortuitous (though, as noted yesterday, one that it is unlikely to come close to reaching) that it could achieve that goal just as the Fed reduces trillions in bank reserves.
Leave A Comment