Ben Bernanke has penned an op-ed for the Wall Street Journal on how exactly he proposes the US central bank will withdraw from quantitative easing in time to stave off an undesirable amount of inflation.
Here’s a taster:
. . . As the economy recovers, banks should find more opportunities to lend out their reserves. That would produce faster growth in broad money (for example, M1 or M2) and easier credit conditions, which could ultimately result in inflationary pressures—unless we adopt countervailing policy measures. When the time comes to tighten monetary policy, we must either eliminate these large reserve balances or, if they remain, neutralize any potential undesired effects on the economy.
Those tightening devices include simply shrinking reserves by winding down short-term credit facilities or allowing securities held by the Fed to mature. Alternatively there’s the option of paying higher interest on reserve balances, a power given to the Fed last Autumn, and which encourages banks to keep reserves at the central bank instead of lending them out to the wider economy. In addition, it can arrange large-scale reverse repurchase agreements — selling securities from its portfolio with an agreement to buy them back at a later date — or it can sell Treasury bills and deposit the proceeds with the Fed, offer term deposits to the banks or sell a portion of its long-term holdings into the open market.
Sound complicated?
Bank of England deputy governor Charlie Bean was much more simplistic succinct in his Monday interview with the, err, the Nottingham Evening Post:
While Mr. Bean and his Bank of England colleagues have travelled around the country trying to explain how quantitative easing works, little has been said about how the bank will take its “new” money back out of the economy.
The first sign that this process is underway will come with an increase in interest rates, still languishing at their historic low of 0.5%.
Mr Bean said: “At some stage, as the economy starts recovering, we will have to withdraw the stimulus.
“We can do that in two ways – by raising the bank rate (interest rate) in the normal way, or by selling back some or all of the assets we have bought.
“It is quite likely we will in the first instance raise bank rate. We can then start selling the assets we have bought at a rate which recognizes the market circumstances at the time.
“In the terms of the trigger, the key thing will be the inflation outlook. When we think the recovery is such that it looks like the risks are that we will overshoot the 2% inflation target, we will need to start withdrawing the stimulus.”
Of course, the things these two approaches have in common is the idea that the central bank will somehow ‘know’ when the deflation risk has subsided and the inflation risk has appeared. However, their approaches to measuring that risk (reliance on the output gap, etc.) have already been criticised.
And while the central banks insist the risk is still to the deflationary side, the market, with the recent rally in equities, seems to be squarely erring on the side of inflation (or at least the avoidance of deflation) – hence the need, presumably, for Mr Bernanke’s and Mr Bean’s sudden spate of QE-related media appearances in the first place.
All of which brings to mind the old parable… Ah wait, did you hear something?
Related links:
Bernanke: Here’s how we’re going to avoid Zimbabwe-like inflation – Clusterstock
Of bonds and stocks and the Weimar Republic – FT Alphaville
Inflation and the QE exit strategy – FT Alphaville
Sticky inflation, redux - FT Alphaville