During the Great Recession of 2007-2009, the Federal Reserve employed a policy known as quantitative easing. Essentially, the Fed purchased large quantities of government securities and mortgage bonds in order to reduce interest rates and improve credit markets by increasing the money supply. Although an unconventional monetary policy, it aims to boost the economy and promote lending and liquidity by flooding it with capital. Now that the Federal Reserve is beginning to reverse quantitative easing, this could largely disturb financial markets. However, officials of the Fed have reassured Wall Street that the reversal will be gradual enough to prevent market impact.
The Fed plans to accomplish gradual reversal of quantitative easing by stopping reinvestment of all the money into the central bank's portfolio when assets mature. As a result of this, the Fed's $4.5 trillion balance-sheet will slowly begin to shrink. The plan is to begin with a $10 billion roll-off this upcoming October and increase it quarterly until it reaches $50 billion a month by October 2018. Philadelphia Fed President Patrick Harker commented that the goal is for the policy to be the "equivalent of watching paint dry." However, Scott Anderson, chief economist at Bank of the West, has a different opinion on the effects of this reversal. He believes that the Fed is being too optimistic regarding the impact that this reversal might have on the U.S. economy. Anderson also believes that simultaneously reducing the balance sheet and hiking the fed fund rate could potentially be too much tightening too soon which could result in drastic effects.
Most commentators view a large balance-sheet (which is representative of quantitative easing policies) as a huge economic stimulus. That is why on September 20th, Janet Yellen, chair of the Federal Reserve, announced that the balance-sheet should shrink because the stimulus it provided to the economy is not needed anymore. Fed policymakers are currently projecting that the central bank will raise interest rates 3 more times in 2018 and in 2019.
Reversal of quantitative easing thus brings uncertainty about the path of interest-rates. Inflation currently continues to fall short of the Fed's target which may indicate that the labor market is not as firm as the percentages suggest. Scott Anderson has said that "bond market inflation expectations remain well below historical norms, and the two- to 10-year Treasury spread has narrowed since the beginning of the year," which could be a sign that the Fed is pushing too hard to normalize monetary conditions and that inflation is at risk. Such effects could prompt the Fed to reconsider its policies and delay its reversal of quantitative easing.
