Quantitative Easing - Time to Think About How to Exit

In the WSJ, Fed Chairman Ben Bernanke explains the Fed's exit strategy from quantitative monetary easing. It relies on two pillars:

The first pillar is paying interest on bank reserves with the aim of giving banks incentive to redeposit excess liquidity with the Fed instead of letting them push monetary aggregates. It is noteworthy that Bernanke explicitly refers to M1 and M2, not only credit aggregates! Both, paying interest on reserve accounts and looking at monetary aggregates has always been part of the monetary policy framework of the ECB.

The second pillar is curtailing the Fed's balance sheet. For this, Bernanke considers four measures. 1) Reverse repos: they may be suitable if a temporary down scaling is aimed at, but I doubt that it suits if one needs a permanent withdrawal of monetary expansion. 2) The Treasury selling bills and depositing the proceeds with the Federal Reserve: a severe threat to the Fed's independence, without which inflation will be unleashed - it's like casting out devils through Beelzebub. 3) Term deposits: nothing new from a European perspective. 4) Sale of long-term securities into the open market: maybe the most natural way of thinking about curtailing monetary expansion, but there is very little experience with block sales of that size and with these market segments in question.

On of the most interesting questions is whether inflation is more of a problem in the US than in the Euro area. To find an answer one should recognize that 1) monetary policy has been more expansive in the US, and 2) the tools needed to curtail monetary expansion have been already available to the ECB from the outset, so that market participants are more experienced with them in the Euro area than in the US.

Expanding regulatory power of central banks

There has been a controversial debate going on about whether or not to expand the power of central banks by giving them mandate to regulate and supervise private financial institutions (like banks). As the NYT reports there are many different pros and cons. Among the critics are Allan H. Meltzer (we discussed some of his views already here) and John B. Taylor (we mentioned him here), both distinguished monetary economists, yet each from a different angle. Meltzer is concerned about the Fed's proven inability or unwillingness to do something about financial stress; he therefore claims that the Fed is not the right institution to be charged with financial stability. Taylor says that expanding the Fed’s power would dilute its main mission of steering the economy, create conflicts of interest, reduce its credibility and jeopardize its independence.

From an economist's point of view it is still an open question how financial stability and macroeconomic stability are interlinked and whether a central institution should be in charge of both.