Fed researchers gauge tightening from balance sheet normalisation

The effect of the Federal Reserve’s quantitative tightening is “relatively modest” in comparison to the degree of monetary accommodation provided through quantitative easing, research published by the Fed says.

In an economic letter, Cynthia Doniger and co-authors set up two scenarios: a baseline scenario where the Fed reduces its balance sheet as it has done since 2014; and an alternative scenario where the asset holdings are kept constant. The authors then examine what adjustments to the federal funds rate would be required to achieve the same macroeconomic outcomes in the Fed’s March projections. 

Since the Fed began its balance sheet normalisation programme in 2014, the path for the federal funds rate is on average 30 basis points below what it would have needed to be without the programme, the authors find.

To achieve the Fed’s 2019 projections, the federal funds rate would have to be roughly 20bp higher than it otherwise would be in the second quarter of this year, they find.

In contrast, the asset purchases were estimated to have reduced 10-year Treasury yields by as much as 100bp.

The study provides “a useful framework that can help the public better understand the effects of balance sheet policy on broader macroeconomic outcomes”, the authors say.