QEDead

As expected, the US Federal Reserve announced today that it will end its quantitative easing program (well, sort of -- more on this below), in view of the continuing improvement in the US economy.  It emphasized that it would not consider raising interest rates for a "considerable" period of time, but also hardened its rhetoric slightly by removing the adjective "significant" from its description of the degree of slack in the labour market.

This piece by the BBC's Robert Peston is a bit rambling and repetitive, but it's not a bad summary of what we know about the good and bad achieved by half a decade of unprecedented money creation. As Peston notes, fears that QE would set of a bout of unbridled inflation have proven unfounded. At the same time, hopes that QE would get the US economy back on its feet have been agonizingly slow to materialize.  Companies have been reluctant to take advantage of exceptionally low borrowing costs to increase investment, while banks have been equally unwilling to extend fresh credit than the Fed and other central banks had hoped.

It's perhaps worth reminding ourselves here that central banks (and governments) have in effect spent the past five years trying to get banks to suck and blow at the same time -- providing credit to finance business expansion while aggressively getting their own balance sheets back into shape.  As last week's news out of Europe suggests, this latter process is still not complete, with a couple of dozen institutions still failing to meet capital requirements.

Despite the Fed's cautious optimism, there's still a real risk that the US could find itself in another bout of stagnation if growth continues to slow in China and fails to recover in Europe.  If that happens, asset prices, which have certainly been boosted by QE even if the broader economy hasn't,   would come under pressure.  This loops us back to the point in the first paragraph, that the Fed has only "sort of" ended QE.  The program may be over, but the Fed's balance sheet stands at a staggering $3.7 trillion, eight times larger than it was before the QE purchases started. Nobody seems to have much idea what to do about that, but if the Fed can't begin the process of shrinking its balance sheet fairly soon, how much room to maneuver will it have when the next crisis rolls around?