On December 10, the US Federal Reserve surprised everyone by announcing that it would begin expanding its balance sheet again on December 12, just a few days after it had stopped reducing it.
Although it came earlier and was stronger than anticipated, the Fed's balance sheet expansion should not be interpreted as a new phase of quantitative easing, or QE. The Fed launched this type of program during the 2008 financial crisis and then in response to the Covid-19 shock in March 2020. On both occasions, it expanded its balance sheet by purchasing large quantities of long-term government securities, thereby injecting a large amount of central bank money into the financial system. These QE programs helped ease financial tensions and support economic activity by pushing bond yields down. Nothing comparable is happening today. The Fed will once again inject liquidity, but its purchases will focus on short-term securities and, above all, they are not expected to increase the size of its balance sheet as a proportion of GDP, unlike past QE experiences.
The decisions taken on December 10 are more reminiscent of those taken in the aftermath of the securities repurchase market crisis in September 2019. At the time, the Fed greatly underestimated the effect of the new liquidity rules on central bank money needs of banks. It had waited far too long to halt its balance sheet reduction program, or QT. This had depleted the reserves that banks held in excess of their needs, preventing them from meeting cash demands at a critical moment. Short-term market rates had skyrocketed, forcing the Fed to intervene urgently.
The tensions perceived in the money markets in recent months, which were certainly less severe than at the end of QT1 but nevertheless persistent, convinced the Fed that the stock of central bank money was no longer sufficient to ensure the effective transmission of its monetary policy. To remedy this, it is removing the aggregate ceiling on these securities repurchase agreements and reactivating its outright purchases of T-bills. The pace of these purchases will be specified as they progress, but will clearly be fairly sustained at least until next April in order to avert the risk that the closing of annual accounts in December and the payment of taxes in April will exacerbate liquidity tensions. Beyond that, the Fed will calibrate its purchases so as to maintain its supply of central bank money at a level it deems sufficiently “ample,” probably above 10% of GDP. In addition to their effects on the money markets, these purchases will make the Fed one of the main net buyers of T-bills in 2026 and contribute to the steepening of the yield curve.
However, the Fed will not be able to avoid continuous monitoring of bank balance sheets and money markets, as it is required to do so by the regulatory framework. Yet central bank money needs of banks are very difficult to quantify. Successive crises and QE, the decline in the value of collateral, and the expectations of banking supervisors since the run on deposits in March 2023 have increased these needs. The continued expansion of the securities repurchase markets, which accompanies the widening of the US public deficit, and innovations in the payments sector are likely to increase them further. The difficulty will be in assessing the extent of this increase.
