Quantitative easing has concluded in the world’s largest economy — at least for now. Almost nine years after the U.S. Federal Reserve started its unprecedented programme of liquidity infusion through the purchase of asset-backed and Treasury securities in the wake of the global financial crisis, Fed Chair Janet Yellen announced on Wednesday that starting next month the central bank would begin the normalisation of its balance sheet.
To their credit, Ms. Yellen and her colleagues on the Federal Open Market Committee have walked the talk on their June decision to unwind the mammoth $4.5 trillion balance sheet. Most crucially, they have done it in a manner that precludes the risk of a ‘taper tantrum’ similar to that in 2013 — when Chairman Ben Bernanke had hinted at starting to turn off the tap — by setting out a slow, long-drawn and well-calibrated timetable to shrink the Fed’s holdings. The asset wind-down will begin with monthly reductions of a modest $10 billion in the three months through December. That amount will gradually increase in quarterly increments of $10 billion so as to reach, in October 2018, a monthly cap of $50 billion. It will continue at this level till such time the Committee concludes that the size of the central bank’s asset holdings is optimal for the effective conduct of monetary policy. Interestingly, Ms. Yellen, who asserted that the balance sheet was not intended to be an “active” policy tool in normal times, especially now that economic activity had strengthened, also placed a caveat. The Fed, she said, “would be prepared to resume reinvestments” if the economic outlook were to deteriorate so significantly as to warrant “sizeable” interest rate cuts.
Not that Ms. Yellen sees the healthy expansion undergirded by household spending weakening, the damage from the recent hurricanes that have battered coastal regions in the U.S. south notwithstanding. The FOMC has, in fact, marginally raised its median projection for U.S. real GDP growth in 2017 to 2.4%, from the 2.2% estimated in June, and signalled that it is on course to raise the federal funds rate one more time this year after leaving interest rates unchanged for now. However, the one element in the Fed’s policy calculus that eludes, in Ms. Yellen’s words, a more perfect “understanding” is the lower-than-anticipated trajectory of inflation. Given that monetary authorities in the U.S. are focussed on reflating the economy by supporting “further strengthening” in the labour market through an accommodative stance, the central bank has to remain vigilant in warding off any let-up in expansionary momentum. For Indian policymakers, there are both positive and not-so-welcome cues. While the ongoing moderate expansion in the U.S. bodes well for the country’s struggling exporters, the end of easy money conditions could augur a slowdown in investment inflows from abroad and resultant pressure on the current account deficit. The Reserve Bank of India, though, should welcome the clarity in messaging from its U.S. counterpart.
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