The Economist - USA (2021-07-10)

66 Finance & economics TheEconomistJuly10th 2021

end of the year. The Fed’s careful approach might reflect lingering memories of 2013, when it last warned of tapering to come. Bonds sold off sharply, the dollar soared and emerging markets suffered capital outflows in what is now known as the “tap er tantrum”. Even Mr Powell’s announce ment in June was accompanied by a mini tantrum of sorts. Prompted by higher infla tion, officials also indicated that they ex pected to raise interest rates twice by the end of 2023, sooner than they had previ ously signalled. The hawkish turn sent emergingmarket currencies tumbling. qeis swathed in so much mystical un certainty that working out the impact of unwinding it is no easy feat. But a careful examination of central banks’ past experi ence of asset purchases yields clues for what to expect. It also contains lessons for how central banks might be able to extri cate themselves from their bondbuying gracefully this time, before the negative sideeffects of their enormous balance sheets start to be felt acutely. Begin with the effects of changing course. Everyone agrees that central banks’ asset purchases reduce longterm bond yields. But there is enormous uncertainty as to how much they underpin markets to day. Last year Ben Bernanke, the Fed’s chairman at the time of the taper tantrum, suggested that in America in 2014 every $500bn of qereduced tenyear Treasury yields by 0.2 percentage points. By that rule of thumb, adjusted for inflation, the Fed’s total securities holdings of $7.5trn to day are lowering yields by nearly three per centage points (though Mr Bernanke sug gested, somewhat arbitrarily, that the over all effect of qemight be capped at 1.2 per centage points). Alternatively, the median estimate of a survey of 24 studies conducted in 2016 by Joseph Gagnon of the Peterson Institute for International Economics suggests that as set purchases worth 10% of gdpreduced tenyear government bond yields by about half a percentage point. That suggests that qetoday is suppressing longterm rates by just under two percentage points in Amer ica, Britain and the euro area—although Mr Gagnon argues that when yields approach zero, as they have in Europe and Japan, qe reaches its limits. A bigger bond market may also reduce the size of the effect. The Bank of Japan owns government debt worth a staggering 97% of gdp, but Mr Gag non finds the effects of qe have historically been more muted, perhaps because Japan’s total public debt is more than twoanda half times that figure. These numbers, and the experience of the taper tantrum, make the reversal of qe seem like something that will upend fi nancial markets. Skyhigh asset prices to day reflect the assumption that longterm interest rates will stay low for a long time.

“Weknowweneedtobeverycarefulin communicating about asset purchases,” MrPowellacknowledgedearlierthisyear. Yetthelessonsfromthetapertantrumare subtler than they seem—and may even providesomecauseforcomfort.

Whenthetoysgooutofthepram Thetantrumof 2013 isassociatedwithMr Bernankeraisingthesubjectofslowingthe Fed’s paceof assetpurchases.But asset pricesfellbecauseinvestorsbroughtfor wardthedateatwhichtheyexpectedthe Fedto raiseovernight interestrates,the traditionalleverofmonetarypolicy.The episodesupportsthe“signalling”theoryof qe, whichsaysthatcentralbanks’balance sheetsinﬂuencelongtermbondyieldsnot directly,asrulesofthumbsuggest,butby actingasa markerforfutureinterestrates. Theimplicationisthatyoucanreverseqe withoutmuchfussifyousevertheper ceivedlinkbetweenassetpurchasesand interestratedecisions. Somepastepisodesoftaperingseemto observethisrule.Indeed,theFedhasalrea dyachieveda bigtapering duringtheco vid19crisis.Astheseverityofthepandem icbecameclearandmarketspanickedin spring2020,theFedhooveredupalmost $1.5trnofTreasuriesinjusttwomonthsbe fore dramatically slowingits purchases,

whicheventuallysettledataround$80bna month.Buttherewasnoexpectationthat interestrateswouldsoonriseandbond yields seemed unaffected. In a speech GertjanVliegheoftheBankofEngland,a proponentofthesignallingtheory,cited this experience, which was mirroredin Britain,asevidencethatthereislittleme chanicallinkbetweenbondyieldsandqe. TheFedalsoseemedtoachievesucha separationthelasttimeitshrankitsbal ancesheetsignificantly,in 2018 and2019. It letassetsmaturewithoutreinvestingthe proceeds,ratherthanbysellinganything— withnodiscernibleeffectonbondyields. “Thepointaroundsignallingandintentis a verysalientfeatureofhowqeoperates,” saysa traderata bigWallStreetbank.Since theendofMarchtenyearTreasuryyields havedrifteddown,evenastaperingtalk hasbecomelouder. Perhaps,then,centralbankscanpull offa gracefulexit.Thequestioniswhether risinginflationandboomingmarketswill make them impatient to reverse course moreabruptly.Some,particularlyinBrit ain,arealsowaryofthreepotentialunde sirableeffectsofcentralbanks’balance sheetsbeingtoolargefortoolong. Thefirstconcern,whichhastroubled MrBailey,is aboutpreservingammuni tion.A popularviewisthatqeishighlyef fectiveatcalmingmarketsduringcrises whenitisdeployedquicklyandatscale, but hassmaller effects inmore normal times.Thedangerofprolonginganenor mousmarketpresence ingood timesis thatyourunoutofroomtoactwithforce duringemergencies.Centralbankersusu allyscornthislogicwhenit isusedtoargue forhigherinterestrates,becauseharming theeconomytodaytorescueitlateristo putthecartbefore thehorse.But ifqe worksbestina crisisthenwithdrawingit innormaltimesshouldnotbesopainful. Notdoingsomightmeana gradualratchet ingup,duringeachcrisis,oftheshareof governmentdebtthatcentralbanksown. Thesecondworryistheunseemlytan gleofmonetaryandfiscalpolicythatqe creates. During the pandemic central bankshaveroutinelyfacedtheaccusation thatqeismeanttofundgovernments;in Januarya surveybytheFinancialTimesof the 18 biggest investors in Britain’s gilt marketfoundthatthe“overwhelmingma jority”thoughtthepurposeoftheBankof England’sbondbuyingwastofinancethe government’semergencyspending,rather thantosupporttheeconomy. Butalthoughlowerbondyieldshelpthe government’sfinances,qedoesnotextin guishthegovernment’sfinancingcosts.It justshiftsthemtocentralbanks,whose profitsandlossesendupbackwiththetax payer.Thecentralbankreservescreatedto buybondscarrya floatingrateofinterest, makingthemanalogoustoshorttermgov

Shopping spree Asset purchases by central banks, $trn Developed markets

Source:JPMorganChase

1

30 25 20 15 10 5 0 22152009

Stock

F’CAST

10 8 6 4 2 0 -2 22152009

Annual flow

F’CAST

Treasury trove Government debt held by central banks July 2nd 2021 or latest available

Sources:Nationalstatistics; HaverAnalytics;TheEconomist *201figures

2

United States

Britain

Euroarea

Japan

50250

%ofbondsoutstanding 100500

% of nominal GDP*

The Economist - USA (2021-07-10)

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