QE without QT


  • The latest Fed minutes imply that QT may end in late 2019
  • This is good news for the US economy (and President Trump) in 2020
  • It also has implications for how future QE may be undertaken

After a weak second half in 2018, US broad money developments have picked up. While the 12-month rate of growth of broad money (roughly equivalent to the old M3 measure discontinued by the Fed in 2006) was unchanged at 2.7% in January, that is still up from a low of 1.4% in the year to September 2018. More to the point, on a 3-month annualised basis, broad money growth was 5.2% in December and 4.9% in January, the strongest numbers since early 2017. 

This buoyancy is very much driven by a resurgent growth in credit. Total credit to the non-bank private sector rose by more than 4% in the year to each of the months November, December and January. Weekly credit data shows the 13-week (i.e., three-month) annualised growth of total loans and leases in bank credit at between 7% and 8% since early January, with double-digit growth in commercial & industrial loans. On the liabilities side of the banking system balance sheet, there has been a surge in large (i.e., exceeding $100,000) time and savings deposits. Changes here tend to lead similar changes in in share prices.

In addition, the long-term outlook for broad money growth has improved further. The latest Minutes from the Federal Open Market Committee show a high likelihood that the Fed’s slimming of its balance sheet — quantitative tightening or QT — will end this year. (“Almost all participants thought that it would be desirable to announce before too long a plan to stop reducing the Federal Reserve’s asset holdings later this year.” Minutes from meeting 29-30 January.) Such a move would automatically boost broad money growth and numbers in the 6-8% range could well be the norm by end-2019 and early 2020. In turn, that would signal very healthy US economic activity in 2020. (It would also most likely boost President Trump’s re-election chances, already high as long as the Democrats persist in fielding candidates which are, by US standards, of the far left.)

But the Fed’s action has another interesting and perhaps often overseen consequence. This has to do with how future quantitative easing (QE) might be undertaken. If the Fed stops QT this year, it will retain in excess of $3tn of US debt on its balance sheet; approximately one-seventh of total US public debt.

Although the Fed, like most other central banks, is keen to portray QE as an ‘unconventional’ measure, it is clear that, should circumstances in the future so warrant, it will be used again. In fact, it is likely to be a measure of early (perhaps not first, but certainly not last) resort in a crisis. This is the more likely since the fall in the neutral interest rate means that policy interest rates are more likely to come up against the effective lower bound (ELB) than in previous decades.

But this also means that, if conducted by the Federal Reserve, the central bank could quickly become the dominant owner of US public debt. In Japan, this already the case, with the Bank of Japan holding the close to 50% of all outstanding Japanese Government Bonds (JGBs) at the end of 2018.  But US Treasuries are a lynchpin of the global financial system; and a situation where the central bank owns much, perhaps even most, of the public debt, is unlikely to be acceptable in the USA in the same way as it is in Japan.

However, there is another possibility. So far, QE has everywhere been carried out by the central bank. But this is not necessary. In fact, it could be argued that it would be more efficient for QE to be carried out by a treasury/ministry of finance. In other words, the treasury would use its overdraft account with the central bank to buy assets from the non-bank private sector. 

There are three advantages with letting the treasury, rather than the central bank, be the buyer.

First, it avoids the risk of the central bank becoming a dominant holder of any one financial asset.

Secondly, it avoids the problem of a huge central bank balance sheet. In itself, this is perhaps not an issue. But it does mean that the central bank has greater exposure to losses which could threaten its independence. (In fact, if the central bank buys bonds, it will by definition suffer losses if its policy is successful.) Although a central bank theoretically cannot go bust, any capital injection will ultimately come from the taxpayer via the government, exposing the central bank to the political pressure.

And thirdly, if a treasury buys government debt, it can cancel it. Occasionally, the idea has been mooted that governments, burdened by a surge in debt following the Great Recession, should simply cancel the debt held by their central banks. However, cancelling debt held by another entity (a central bank), even if part of the public sector, would by any standards constitute a default. By contrast, since a treasury is the issuer of government debt, it would in this case be holding both the liability and the corresponding asset. Retiring the debt would thus simply mean cancelling its own matching assets and liabilities, without this being a default.