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We have been tracing the path of the Federal Reserve’s efforts to conduct monetary policy using either quantitative easing or quantitative tightening.
The approach to monetary policy has been particularly effective in achieving the goals the Federal Reserve set out to achieve.
I would argue that the reason why their “quantitative tools” are effective is that they build up “trust” in what the Federal Reserve is doing and thereby allow the Fed to proceed with the policy process with market participants fully aware of what is going on.
Notice, for example, what has happened in the foreign exchange market.
Nominal Broad U.S. Dollar Index (Federal Reserve)
Notice that this chart begins just about the time Federal Reserve Chairman Ben Bernanke begins the first round of quantitative easing, For most of the time through this time period, the Fed was pursuing quantitative easing and then, beginning in March 2022, quantitative tightening.
For most of this time the “Nominal Dollar Index” rose… the U.S. dollar got stronger.
It is notable that during the period between economic recessions… July 2009 and February 2020… the compound rate of inflation in the United States was only around 2.3 percent.
Inflation was under control and was lower than almost every other rate of inflation of a major currency in the world. The U.S. dollar led the market.
Over the past two years since, the Federal Reserve began its efforts to slow down the rise in inflation by the use of quantitative tightening.
Again, the United States has been leading the world in inflation control.
The strong value of the U.S. dollar reflects this monetary control.
This is what Mr. Bernanke was looking for in constructing these policies.
He writes in his book “21st Century Monetary Policy” that the policy of quantitative easing should lower longer-term interest rates, should result in stock prices rising, and should strengthen the value of the U.S. dollar.
Economic growth should also rise.
All this while keeping inflation down.
The record from the 2010s supports these results.
We have a different situation in the case of the Fed’s quantitative tightening.
Before the Federal Reserve began to tighten up on monetary policy in 2022, efforts had been made on the part of the Fed to pump money… lots of money… into the financial system, combating the efforts the Federal Reserve had made to fight against inflationary pressures. The concern of the Fed at the time was that in its efforts to combat the Covid-19 pandemic and the subsequent economic recession, the Fed had pumped some $4.0 trillion to $5.0 trillion into the banking system in order to “err on the side of monetary ease” and avoid any serious deflationary impacts on the economy.
It was these excess reserves that “scared” the Federal Reserve and the banking system and made them afraid of any excess inflationary pressures that might be around.
The Federal Reserve has been conducting a monetary policy of quantitative tightening since March 2022 and this quantitative tightening has resulted in the removal of $1.4 trillion of securities from the Fed’s portfolio of securities held outright.
The financial markets seem to understand the need for the Fed to remove these securities from the Fed’s portfolio, but a question still remains about just how many dollars are going to be removed from the portfolio.
Securities Held Outright (Federal Reserve)
From this chart, one can see how the Federal Reserve purchased lots and lots of securities during the economic recession, and also continued to buy more and more securities up until the middle of March 2022.
The Fed went into quantitative tightening on March 16, 2022. One can see how persistent and steady the Federal Reserve has been since the March 16 date.
The Federal Reserve has built up “trust” within the marketplace. Investors believe that the Fed will continue to keep reducing the Fed’s portfolio of securities held outright.
But, the Fed bought a lot of securities before it turned around and began its quantitative tightening efforts.
Right now, investors are responding to what the Fed is doing by moving stock prices higher, moving bond prices higher, and by supporting the value of the U.S. Dollar.
The market is saying… “we trust the Fed…” and we want the Fed to continue on it path of quantitative tightening.
This is a new era. Ben Bernanke, when he was Chairman of the Board of Governors of the Federal Reserve System, introduced a new form of monetary policy to the Fed. This is what we are seeing in place right now.
To get a better view of Quantitative Easing and Quantitative Tightening, read Mr. Bernanke’s book “21st Century Monetary Policy,” published by W. W. Norton & Company, published in 2022. Every investor should be very aware of what Mr. Bernanke has proposed.
