Capping QE

After next week’s FOMC meeting, we are likely to hear a lot more about the central bank’s plans to unwind their experiment with asset purchases of public and private debt securities as a therapy whatever ails the economy during periods of financial stress. Indeed, Fed officials already have made clear that they intend to begin to shrink their balance sheet later this year through some process of attrition. For those observers who have a long view on monetary issues and the efficacy of financial markets, this news should come as a welcome relief because central banks in general should not make a habit of such large-scale interventions lest they cause permanent distortions and collateral damage to financial markets. Others with shorter horizons will fret about the dangers that any exit strategy has the potential to create volatility, reminiscent of the ‘taper tantrum’ of 2013, and to tighten monetary conditions enough to undermine the economy’s slow-moving recovery. Of course, Fed officials must take the long view and hence tend to believe they can engineer a graceful exit. Their plan is somewhat akin to ‘cap and trade’ schemes for weaning the world of pollutants. Unlike those supposedly market-based plans, which can be more complicated and less effectual than advertised, the Fed’s exit strategy seems to have considerable flexibility including the option to change course if need be.

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