Quantitative Easing: The Exit Strategy

            The Fed has recently announced that it will renounce to Quantitative Easing policy. Alan Blinder has a very interesting material that explains pretty well the rationales for why has the FED chosen this approach, how was implemented and what are the exit strategies.

Without stressing this point too much, the main reason for choosing to implement Quantitative Easing was, in the first place, the liquidity trap. Unfortunately, this concept is quite controversial and I discussed a bit about it here: “Is the US in a liquidity trap?”.

However, it is much more interesting to see what the options for exiting the quantitative risks as well as the potential risks associated to the exit strategy, see the speech by Bernanke on the exit strategy by the FED. One natural course is to let assets flow free, that is, to close the liquidity facilities (which was almost done through the completion of TAF and MBS purchase programs). On the other hand, the exit strategy also has to deal with the open market operations. They could have contractionary effects by reverse repurchases or by direct sales.

Blinder correctly underlines the difference between an exit strategy based on lending facilities and an exit strategy using open market operations. In the first case, the exit is rather natural, while in the second, there are potentially many risks.

The most dangerous issue seems related to the issue of shrinking the bank reserves. It is well known that excess reserves have piled up in huge amounts. Probably this is a potential source of inflation (see the article by Feldstein on why US inflation remained low).

The IMF has also underlined possible risks to the exit from Quantitative Easing. According to IMF, the tightening could imply an increase in interest rate volatility (and potential negative effects on emerging economies). A potential solution to the possible interest rate volatility was suggested by Alan Blinder in the form of setting an interest rate corridor, with both a floor and a ceiling.

As the FED exits the Quantitative Easing, we might see new development which could prove if this strategy was a wrong approach or not.


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