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Taming the Monetary Beast
As the momentous monetary policy measures by the United States Federal Reserve—the decade-long quantitative easing and balance sheet expansion programme—inch closer to an end, this article captures some of the lessons learnt and, more particularly, the ones unlearnt in the last decade. The pivotal role of central bank communication, the impact of monetary policy spillovers, and the changing nature of central bank mandates are perhaps the most important takeaways from a decade of financial turmoil and monetary policy interventions.
On 20 September 2017, the United States (US) Federal Reserve announced the gradual unwinding of perhaps its biggest monetary experiment in history—the decade-long quantitative easing and balance sheet expansion programme. Adopted against the backdrop of the global financial crisis in 2008, and with an objective to revive aggregate demand and economic growth, the Federal Reserve embarked upon a hitherto unprecedented and practically unlimited purchase of long-term US treasury debt obligations and private asset-backed securities. The result—a bloated $4.5 trillion central bank balance sheet representing roughly 24% of the US’s gross domestic product (GDP), a possibility of looming losses for the Federal Reserve, and a fear of the private sector being crowded out.
Notably, the Federal Reserve was not alone in this endeavour. Central banks in other systemic countries (United Kingdom, Eurozone, and Japan) closely followed suit and launched their own versions of quantitative easing so as to influence long-term interest rates in their respective economies (Borio and Zabai 2017). With growth, investment, and employment levels slacking through consecutive quarters, and with no immediate indications of a course reversal, quantitative easing and unconventional monetary policies had come to acquire the status of the new “normal” in monetary policy parlance. Thus, after almost a decade of unusually low interest rates and ultra-cheap money, the Federal Reserve’s U-turn with respect to unconventional monetary policies and its balance sheet normalisation agenda, is indicative of several positive milestones: the revival of growth and investment in the US and the world economy, confidence with respect to an upsurge in inflation and employment, and a restoration of monetary policy transmission channels. It also perhaps signals the growing unease within the Federal Reserve and other policymakers about the potentially counterproductive impact of sustained “accommodative monetary policy” in augmenting asset price mismatches and financial market distortions.
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