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At Ease

Will the Federal Reserve Begin Relaxing Quantitative Easing Policy Anytime Soon? Not Likely

You may not realize this, but the Federal Reserve is the most profitable bank in America - by far. Last year, the Fed’s growing portfolio produced revenue of more than $100 billion. Such is the benefit of costless liabilities and a balance sheet that is not subject to any kind of capital constraint.

Despite the accumulating lucre, the Fed’s bond-buying program is generating concern. Quantitative easing (QE), initiated in 2009, is aimed at improving economic conditions so that unemployment falls meaningfully. And while QE has produced some very tangible benefits, some think that the returns to the effort are diminishing, and the risks associated with it are rising.

First objective achieved
In 1978, Congress directed the Fed to seek price stability and maximum sustainable growth in employment. For most of the intervening years, the Fed has been focused on the first part of this "dual mandate." The taming of inflation over the past generation has been cited as the foremost achievement of the Fed’s first 100 years.

Since the Great Recession, however, unconventional monetary policy tools have been aimed squarely at putting people back to work. Substantial bond purchases by the Fed have brought long-term interest rates down, contributing to the stock market’s rally and heavy mortgage refinancing. These developments have created a "wealth effect" that has spurred spending and helped to reduce joblessness. All of this has occurred in spite of significant headwinds from fiscal policy.

Potential potholes in the road?
Still, the release of such a large amount of reserves into the financial system risks kindling inflation and asset price excesses. Neither is a problem at present, and the Fed’s surveillance of the horizon is much improved. Exit strategies are ready if and when reversing course is called for. But policy is in uncharted waters, and success is not assured.

An increasing chorus of voices inside and outside of the Fed is therefore suggesting that the QE program begin tapering off. To date, however, the Fed has opted to press ahead against a known problem rather than combat problems that have yet to materialize. It will be interesting to see how this tradeoff is debated in the months ahead.

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