Fed Asset Reduction Discussions Intensify: "Should Begin Immediately After Quantitative Easing Ends" Claims

Asset Size Doubled After COVID-19 Pandemic... Tapering Discussions Begin at Last Month's FOMC
Waller Says "Need to Reduce to About 20% of GDP... Reducing Assets Eases Rate Hike Pressure"

[Asia Economy Reporter Park Byung-hee] As the quantitative easing by the U.S. central bank, the Federal Reserve (Fed), is expected to end around March, discussions on how to reduce the increased assets of the Fed are anticipated to intensify.

According to the Wall Street Journal (WSJ) on the 4th (local time), the Fed already began related discussions at last month's Federal Open Market Committee (FOMC) meeting, and within the Fed, there are arguments that asset reduction should start within the year as a means of tightening policy.

The Fed introduced zero interest rates and quantitative easing policies in March 2020, immediately after the COVID-19 pandemic to prevent an economic recession, which caused the asset size to double over the past two years. As of the 27th of last month, the Fed's holdings reached $8.7575 trillion. Right after the COVID-19 pandemic began, the Fed injected nearly $1.5 trillion into government bond purchases and soon announced a quantitative easing policy to purchase government bonds and mortgage-backed securities (MBS) with at least $120 billion monthly. The Fed started tapering, gradually reducing asset purchases under quantitative easing, in November last year, and according to the current plan, the quantitative easing policy will end around March. The Fed's assets will no longer increase.

Now, it is time to discuss when and how to reduce the increased assets. Related to this, Director Christopher Waller said that the current Fed asset size is about 35% of the U.S. Gross Domestic Product (GDP) and that it should be reduced to around 20%.

The Fed can reduce its asset size by not reinvesting in new issues when bonds mature. Conversely, it can maintain the existing asset size by reinvesting in new issues of matured bonds.

The Fed is known to have already discussed how to reduce its holdings at last month's FOMC. At that time, Fed Chair Jerome Powell said at a press conference after the FOMC that no decision had been made yet.

During the third round of quantitative easing, the Fed maintained its asset size for three years before gradually reducing it. The Fed started the third quantitative easing in September 2012 and ended it in October 2014. Afterward, the Fed maintained its holdings for three years and began the so-called "normalization" process of reducing asset size from October 2017. At that time, the Fed started reducing holdings by $10 billion per quarter and increased the reduction amount by $10 billion each quarter to accelerate the pace. The Fed continued asset reduction started in October 2017 until 2019 but increased holdings again at the end of 2019 after complaints arose from Wall Street banks about excessive liquidity absorption.

Chair Jerome Powell said during congressional testimony in July last year that the Fed's asset reduction process from 2014 to 2019 could serve as a starting point for discussions. At the press conference after last month's FOMC, he indicated that the Fed would not follow the 2014-2019 approach and would not prolong the start of asset purchase reduction as long as three years, as was the case with the third quantitative easing.

Jerome Powell, Chairman of the Federal Reserve (Fed)
[Photo by AFP Yonhap News]

Chair Powell cited the current U.S. economy being much stronger than in October 2017, when the Fed began reducing holdings after the third quantitative easing, as a reason. Powell said, "The current U.S. economy is much stronger than at that time," and "It is close to full employment." In October 2017, the U.S. inflation rate was below the Fed's monetary policy target of 2%, but now it has surged to the highest level in about 40 years, around 6%. The current unemployment rate is also lower than in October 2017. Powell said, "This is not just a matter of different economic conditions," and "This should be kept in mind when deciding how to handle the current assets."

Within the Fed, there are also opinions that after ending quantitative easing, holdings should be reduced much faster than in the past.

Director Waller said, "There is no reason to delay asset reduction," and "If some asset reduction begins around summer, the Fed can reduce its burden." He added, "Reducing holdings quickly can be a way to implement tightening policies without rushing to raise the benchmark interest rate."

James Bullard, President of the Federal Reserve Bank of St. Louis, also expressed support in November last year for reducing assets immediately after the Fed ends quantitative easing.

Over the past decade, the proportion of short-term bonds in the Fed's holdings has increased. Accordingly, there is also a forecast that assets could decrease relatively quickly once asset purchase reduction begins. Some analyses suggest that about $3 trillion could be reduced over approximately two years.

This content was produced with the assistance of AI translation services.