Quantitative Easing (QE) is a bond-purchasing program where central banks buy government and corporate bonds as well as mortgage-backed securities. Central banks around the world have used QE during the pandemic to stimulate the economy and lower yields on long-term bonds. Printing money to buy these assets, inflation can occur not long after. But QE is still relatively new, it only really started being in the U.S. in 2007-2009 during the financial crisis and was started back up again in 2020 during the Covid crisis. Not everything is known about the effects of QE and its effects but its generally known for reducing 10-year treasury yields by 100-200 basis points (although contested by some) and stimulating the economy. Yet what is supposed to happen when recessions or crises are over?
Right now is a relatively stable time except for higher-than-average inflation data and worker shortages, it’s still way better than April 2020. What is supposed to happen is Quantitative Tightening (QT), where central banks do not reinvest into bonds when they mature or when they actively sell them. If QE has a powerful effect on markets, wouldn’t QT have an opposite effect? The answer is not so simple, there isn’t much data on QT. The only time the Federal Reserve tried tightening is in 2017-2019 where they reduced their balance sheet by 15% but ended up with a 20% crash in the stockmarket. The pattern that is emerging is that bond-buying will start in an economic crisis, it will slow down purchases gradually, maybe try to stop, then a new crisis will emerge and central banks will now have two sets of QE programs on their balance sheets. They have introduced QE and now are expected to use it as a tool in monetary policy in the future.
If bond yields are lowered by QE, they could rise as a result of QT. Some asset prices may lower because of this. Higher mortgage rates could negatively affect the economy. An overleveraged economy could see problems related to their borrowing costs. A liquidity crisis could also occur. Prolonged QT could be a dangerous experiment within the markets especially when it hasn’t been really tried before.
As central banks establish the usefulness of QE, they need to be prudent while transitioning to QT and need to pay attention to the timing of the business cycle. But the way things are looking right now, the next crisis will most likely occur before assets go back down to a normal/reasonable level. If central banks cannot carefully manage their monetary policy tools, they should not use them.