Unwinding QE

The New York Fed blog wrote a great post yesterday, explaining the process of How should the Quantitative Easing revert.

I think it was a great lesson on monetary policy and mainly on Central Bank Balance Sheet monetary operations.

But… I think it could be better.

Let me try to give my humble contribution.

In the post there is an implicit assumption that the Treasury General Account interacts directly with the Reserves Account (both liabilities of the Federal Reserve) only in one way.

When the Treasury Bonds are issued there is a drain of reserves and an increase in the TGA.

When the Bonds mature, the Treasury pays its due, depleting the TGA and increasing Bank Reserves.


I think we should add another interaction between both accounts.

How is it possible for the Treasury to pay its debts? By having a (temporary) surplus. Therefore the Treasury must drain more Reserves (by taxes) than it injects (by Government Spending). This “destruction” of Monetary Base (Fed´s liability) is accompanied by a decrease in its assets (Treasury bonds).

If, the Treasury issues bonds, it must be to “finance” its deficit (Sorry Mrs. Kelton). This operation (deficit) injects more Reserves (Gov. spending) than it drains (taxes). If the Fed wants to keep its Balance Sheet constant, it must buy some of the new bonds (increase in its assets) by injecting Bank Reserves (liabilities).

This was general proceeding of Monetary/Treasury operations up until 2008 (as we can see in the chart below). Afterwards we live in a strange world where the Treasury issues bonds to help the Fed and not only to fund themselves.


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