That’s the big question, now that we’ve recognised a form of QE is indeed happening in the States.
As Bank of America analysts noted earlier this week:
As in foreign policy, government intervention in financial markets will need equal consideration of an exit strategy as to an intervention strategy.
Yes, and so far we haven’t seen one. Granted it’s still early days in fiscal stimulus, combatting a deflationary spiral is still the over-riding concern, but the Fed needs to get this one right. Its actions on liquidity programmes so far — simply extending them — suggests it’s not even close to contemplating an exit strategy — let alone implementing one.
Merrill Lynch’s US economist Drew Matus made an interesting point on this issue during the bank’s 2009 economic outlook presentation today — namely that if the Fed’s liquidity programmes prove successful and banks actually do start lending to each other once again, the money multiplier — the broken thing that’s been preventing inflation so far — will suddenly start coming into effect, and, in the words of Matus:
inflation will come back
Matus thinks we’ll see the Fed start fixing the fix, so to speak, in the latter half of 2009.
The analysts at Credit Suisse have also latched onto this recently:
Quantitative easing in terms of balance sheet expansion that leaves excess reserves in the banking system simply reflects the collapse in the bank multiplier. Banks have less access to private sector liquidity and must rely on the Fed.
And they’re theorising the following ‘exit’ scenarios:
There are three ways in which the Fed can “reduce” its balance sheet. The first would be to allow securities that it has purchased to mature. This might take a long time and so would imply a long term commitment to quantitative easing anyway, i.e., a lingering deflation threat. The second would be to sell securities. The third would be to run down liquidity programs like the TAF. An alternative exit strategy would be not to reduce the balance sheet but for it to become relatively unimportant as banks expand their balance sheets.
And what about following the example of Japan — the original quantitative easer?
In the case of Japan, the BoJ was able to reduce its balance sheet as part of a generalized tightening of monetary policy… The Fed might be “expected” to do the same, but we think there are important differences, namely that the US is a debtor nation and is reliant on capital inflows. Driving long term interest rates artificially low to stimulate the economy can be successful, but for a debtor economy the “success” might come at the expense of inflation rather than less deflation for price stability.
Related links:
Merrill: Unwinding the West - FT Alphaville
The pictorial Quantitative Easing - FT Alphaville
Quantitative easing, in practice - FT Alphaville
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