Ole MoehrDeploying QT – The Fed readies its new tool to fight inflation, explaining how quantitative tightening (QT) works and discussing the goals and risks of the policy.
On May 4, US time, Feder announced a hike of 50 basis points, raising the target range of federal funds rate to between 0.75% and 1%. This is the first time since 2000 that the rate hike has reached 50 basis points, showing the urgency of the Federal Reserve to tighten the monetary policy . At the same time, the Fed said it will launch the balance sheet reduction plan from June, that is, to carry out quantitative tightening, thereby amplifying the impact of the shrinking interest rate hike.
If quantitative easing (QE) can "reduce borrowing costs, increase expenditures, support economic growth, and ultimately increase inflation ", then the goal of quantitative tightening is exactly the opposite. By reducing the balance sheet, the Fed pulled liquidity from the financial system and increased the lending rate of long-term assets , thereby weakening inflation. The Fed will not sell assets directly at first, but will instead sell passively by not replacing maturing securities.
superimposed implementation of QT policies on the basis of interest rate hikes can further strengthen monetary tightening, but the specific impact is still unclear. According to market analysts at The Economist, the impact of Fed QT policy on financial markets could range between 25 and 125 basis points (1.25%). If QT significantly increases the yield of long-term securities and effectively amplifies the shrinking effect of interest rate hikes, it can prove that QT is a useful tool to help the US economy control inflation and achieve a soft landing.
However, QT also brings potential risks to US and international financial stability. In September 2019, the Fed had to end its first QT plan due to a crisis in the overnight lending market due to a balance sheet reduction. To avoid similar results, the Federal Reserve set up overnight lending tools to ensure banks have enough channels to obtain cash. The uncertainty of the impact of
QT also brings risks to countries with less stable financial systems. While the Federal Reserve and the Bank of England launched QT, the ECB was still continuing to buy assets and insisting on quantitative easing, partly because of concerns that weaker economies such as Italy and Greece are vulnerable to rising yields of sovereign bonds. Rising interest rates combined with the unprecedented QT of developed economies may lead to capital withdrawal from emerging markets, increasing the risk of sovereign defaults and the spread of financial crises.
