MNI: Fed's QT Likely To Be Bumpy Process - Jackson Hole Paper

The Federal Reserve's process of rolling assets from its balance sheet could be bumpy and the central bank should be wary of quantitative easing in the future because it makes the banking system dependent on ever larger liquidity infusions, according to research presented Saturday at the Kansas City Fed's annual Jackson Hole conference.

When the Fed buys assets and expands reserves banking deposits increase and become more demandable also resulting in more corporate lines of credit, the paper said. "We observe little reversal of all this during quantitative tightening. We argue that this asymmetric behavior can explain tightening liquidity conditions and occasional stress when quantitative tightening is underway, despite the central bank balance-sheet being large relative to historical standards," the authors concluded.

The shrinkage of the Fed's balance sheet is not likely to be an entirely benign process and will require careful monitoring of the banking sector’s on- and off-balance-sheet demandable liabilities, authors Viral Acharya, Rahul Chauhan, Raghuram Rajan and Sascha Steffen wrote.

Fed Chair Jerome Powell has said he sees the QT process lasting between 2 to 2.5 years. (See: MNI INTERVIEW: Aggressive Fed Risks Liquidity Squeeze-Hoenig)

"If banks do not reduce the claims they have written on liquidity commensurately as observed in the past QT period, the system could become more prone to liquidity stress," the paper said. "Furthermore, such behavior can make the banking system dependent on the central bank for ever larger liquidity infusions during stress."