The Fed has not even announced the framework of what its balance sheet “normalization” would look like, and already Boston Fed president Rosengren is talking about the next Fed QE program.
In a speech titled “The Federal Reserve Balance Sheet and Monetary Policy” delivered to Bard College on Wednesday afternoon, Rosengren said that structural changes in the macroeconomy “may necessitate more frequent use of large-scale asset purchases during recessions” and he said it is “quite likely” that the use of central bank balance sheets will be necessary in future economic downturns.
The reason? A combination of low inflation, low rates of productivity growth, and slow population growth may imply an economy “where equilibrium short-term interest rates remain relatively low” by historical standards. In other words, the natural rate, or r-star, is so low, the Fed will only be able to hike rates a handful of times before it tip the economy over into contraction, requiring a new easing regime.
As a result, reductions in short-term rates to combat recessions will encounter the zero boundary and “will not be sufficient,” Rosengren said – so “it is likely to be more common for central banks to engage in asset purchases to stimulate the economy by reducing longer-term rates.“
“So balance-sheet expansions – and exits – are likely to become more standard monetary policy tools around the world.“
As a quick reminder, for all the talk of tightening, central banks are currently creating just under $200 billion in new money every month…
… and the total size of the big 6 central banks is now over $18 trillion.
Still, to avoid spooking the market too much – after all the Fed’s balance sheet should shrink before it expands again – Rosengren noted that the Federal Reserve should adopt balance sheet exit strategies “that reinforce the primacy of interest rate policy.” The Boston Fed president said that while the FOMC is still carefully considering its balance sheet exit strategy, his ideal policy “would take a very gradual approach to balance sheet reduction.”
“In my view that process could begin relatively soon, and should not significantly alter the FOMC’s continuing gradual normalization of short-term interest rates,” he said.
Rosengren added that by initially retiring only a small percentage of maturing securities, and then very gradually shrinking the volume of the securities being reinvested, “the tightening of short-term interest rates should not need to be much different than it would be in the absence of shrinking the balance sheet.”
“Starting to shrink the balance sheet earlier – and doing so in a very gradual fashion – implies very little reduction in the degree of monetary stimulus coming from the U.S. central bank’s balance sheet,” Rosengren said.
“This, in turn, will allow policymakers to focus on gradual increases in the federal funds rate target as the primary mechanism for normalizing monetary policy and calibrating the economy.”
But while Fed presidents warning about balance sheet reduction has been the norm in recent months, Rosengren’s unexpected suggestion that a new QE is only a matter of time appears to have spooked stocks, which moments after he spoke, slumped to new intraday lows despite what was an otherwise cheerful speech.
Full speech can be found here.