On Wednesday, September 20, the U.S. Federal Reserve Board announced that it will “initiate the balance sheet normalization program” next month.
The importance of that announcement is not obvious from such bland central-banker-style language. The Fed is going to sell a lot of assets, with uncertain consequences.
Some key history
During the global financial crisis set off by the Lehman Brothers’ bankruptcy, the Federal Reserve did a lot of buying, and not just of Treasury bonds, but of government supported mortgage backed securities as well, all in an effort to pump immediate liquidity into our markets and avoid a civilization-redefining collapse.
The Federal Reserve didn’t announce the end of that buying program for six years. By that time (late October 2014) the asset side of the Fed’s balance sheet included roughly $4.5 trillion in assets. At that point the Fed said that it had concluded “its asset purchase program” but that it didn’t plan to start selling off. Rather, it would keep the holdings of longer-term securities at “sizeable levels,” it expected this would “help maintain accommodative financial conditions.”
So now, three years after hitting the “hold” button, the Fed finally hits the “sell” button. The plan is to sell $10 billion worth of assets next month. That’s almost a trivial amount of the $4.5 trillion whole, but the Chair, Janet Yellen, plainly wants to proceed with caution, keeping the process multi-year and boring.
Right Wing View
The announcement raises a couple of obvious questions. The selloff puts the Fed in competition, so to speak, with the U.S. Treasury itself. Both are in the market selling T bonds. Will there be enough demand to keep buying the bonds from both of these sellers, to soak up the new supply showing up in the market?
Second (related): skeptics maintain that the U.S. economy has become addicted to easy money, which requires both low interest rates and the maintenance of this huge balance sheet. The sell-off by itself will make money less easy: it amounts to pulling the money of the private sector asset buyers out of circulation. That will likely make credit for ordinary people both trickier to get and more expensive even if the Fed does nothing to the Fed funds rate (and for now it isn’t changing that). How great will be the impact of that tightening? Are the skeptics right – is this an addict’s self-help “cold turkey” policy? And if so is it likely to be reversed when the consequences of detox set in?
After Wednesday’s announcement, a story on Reuters’ website quoted various Washington players who were happy to see this normalization. One of these happy folks was Rep. Bill Huizenga (R – MI), who told reporters, “I‘m glad we are finally at this point – I have been encouraging both privately and publicly the Fed to do this. We’ll see whether it truly is an end to the era.”
On some variants of this hurray-for-tightening view, the stock market is now a bubble, where buyers are paying high prices on the theory that they will find a greater fool to buy at still larger prices, and any end to this will be a bad one, but it may be better the end come sooner rather than later. In such a case, “hit us now, Ms Yellen,” may be the right sentiment.
Left Wing View
A common view on the political left is that one of the problems faced by the U.S. economy is the absence of inflation. They believe that Yellen has failed to push for enough inflation, and they surely see this announcement as a step in the wrong direction. Inflation, this presumes, can be a good thing, at least if it is kept within measure. It is thought to be good in the sense that a working bankruptcy system is good – each is a way of relieving the burden of indebtedness. Inflation, of course, does this when and to the extent that the debts are stated in constant dollars.
William Jennings Bryan’s famous demand for the minting of silver was a demand that the currency be inflated by the addition of another metal, precisely in the expectation that this would work to the advantage of the indebted farmers who were Bryan’s core constituency.
There is also the idea lurking to the left of center that any increase of a workers income, even the illusory ‘increase’ of an inflation adjustment, feels like new wealth to the worker and may have a stimulative effect.
For such reasons, Matthew Iglesias, in Vox, wrote recently that one of the problems with the U.S. economy is that policy makers spend their days in “a kind of haze of inflation paranoia carried over from the 1970s.” They should get rid of the paranoia and learn how to use inflation to good ends.
The Financial Times, likewise, observes that there is no evidence of an actual inflationary threat in 2017. It says that the “hawkish tone” of the Fed’s announcement Wednesday – as if war must be waged on a raging wage/price spiral somewhere, is “baffling.”