A Requiem for Bond Buying: A Look Back at How the Fed Supersized Its Balance Sheet
The Federal Reserve's plan to shrink its large portfolio of mortgage and Treasury securities, most likely later this year, marks the closing of a radical chapter in the history of central banking.
Widely referred to by the acronym QE, for "quantitative easing," Fed bond purchases represented a significant and controversial expansion by the Fed into how the economy made credit available to borrowers.
Rather than simply move a short-term rate and allow markets to respond to that narrow benchmark, the Fed purchased trillions of dollars worth of long-term debt to push down an array of real-world borrowing costs, most notably in the housing market. Those years of bond buying took the Fed's portfolio of securities and other holdings from around $800 billion in 2007 to its current level of $4.5 trillion.
The theory was that purchases would lower borrowing costs and increase risk taking -- encouraging businesses and consumers to borrow, spend and invest more than they otherwise would in an era of post-financial-crisis risk aversion. The Fed got steady but disappointingly slow growth, together with gradual declines in unemployment.
QE wasn't entirely a Fed innovation. The Bank of Japan tried it in the 2000s to revive its moribund economy. But Fed Chairman Ben Bernanke saw a flaw in the approach of the BOJ, which focused its purchases on short-term securities.
Mr. Bernanke thought long-term securities purchases would pack more punch in markets and for the economy. He sought to dump the name QE. His term, "Long-term Securities Asset Purchases," never caught on, but before long, other major central banks, including the Bank of England, European Central Bank and the BOJ itself were all trying variations of it.
The Fed turned to long-term bond buying because it had little choice. Officials slashed their short-term, interest-rate target to near zero levels in the final days of 2008, in the depths of the financial crisis and worst economic downturn since the Great Depression. Long-term asset buying became the most visible aspect of policy stimulus, especially because Congress and the Obama administration couldn't agree on fiscal measures. Fed critics warned, erroneously, that Fed efforts to "print money" would fuel an epic surge of inflation. Instead inflation ran below the Fed's 2% goal for years.
Bond buying came in several major episodes, as Fed officials dealt with enduring economic weakness and learned from experience.
The first chapter started in November 2008 with what turned out to be a relative modest effort to buy $600 billion mortgage-related debt in a targeted effort to help restart the battered housing market. In March 2009, the Fed said it would expand that program to $1.25 trillion in mortgage-bond purchases, $300 billion in Treasury-bond acquisitions, and purchases of the corporate debt of Fannie Mae and Freddie Mac.
In November 2010, the central bank said it would add another $600 billion in long-dated Treasury bonds on top of existing purchases.
The autumn of 2011 brought a fresh wrinkle to the Fed's efforts with the announcement of the so-called Operation Twist. Then, policy makers committed to buying even more long-term Treasurys while it sold off short-dated government bonds, in a bid to further lower long-term borrowing costs relative to briefer borrowing terms.
September 2012 brought perhaps the most aggressive phase, as the Fed announced open-ended longer-term Treasury bonds and mortgage purchases. The purchases came to a gradual end in 2014.
Since then, the Fed has continued with bond buying, but only in enough size to replace maturing holdings and keep the portfolio size steady. With no plans to sell securities, the Fed will be progressively reducing the rate of that buying starting this year, which will allow holdings to passively shrink as its holdings mature and don't get replaced.
Officials are unsure how large the portfolio will be in the end, other than to say it will be larger than where it was in 2007.
The Fed may not have seen the last of long-term bond buying either. With short-term interest rates not expected to rise much from current levels, a number of officials have said they are likely to resort to expanding the central bank's balance sheet when the next downturn inevitably arrives.
"We have learned that it works, it's a valuable part of a tool kit," Federal Reserve Chairwoman Janet Yellen said on Wednesday.
(END) Dow Jones Newswires
June 14, 2017 17:41 ET (21:41 GMT)