Quantitative Easing exit or the impossible cock up

Many people express worries about the exit for the Quantitative Easing (QE) process, but then can’t come up with a coherent narrative of how, short of gross incompetence, it could cause a problem.

The basics are very simple, if you’re a central banker you just follow the following algorithm:

  1. if inflation > target then sell some QE assets (this reduces core money supply, more directly than a rate change)
  2. else do nothing (keep them to maturity)
  3. repeat

The most likely scenario is that they do nothing given how hard it is to actually produce inflation outside of full employment. Letting things expire over many years is a very slow incremental process that is unlikely to cause any trouble.

Arithmetically it’s possible that #1 causes a notional loss for the central bank, as they may have to sell their assets for a lower price than they bought it if rates are higher at the time of the sale. But there’s two remedies to this problem (1) if rates go up on their own it puts downward pressure on inflation hence keeping it below target with no asset sales needed, (2) in the unlikely case where you’d get high rates and inflation, the balance sheet of a central bank is unconstrained so they can always either let it go negative, reset it, or book the loss to a perpetual intangible asset (call it “future growth” or what have you).

That works even if you believe QE had much effect in the first place, despite being a mere maturity swap of various kinds of money.

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