Reduction of US Quantitative Easing: Risk Assessment and Normalization

There are changes coming to the crisis-based monetary policy introduced to deal with the COVID-19 pandemic. In November, the U.S. Federal Reserve will begin to gradually reduce the large amounts of capital that has been poured into the market by quantitative easing.

In the United States, the economic climate recovered rapidly once economic activity resumed. However, supply has not kept pace with rising demand, causing prices to rise.

Based on this economic trend, the decision to reduce quantitative easing is reasonable. It is different for Japan, where economic recovery is slower, and economic relief must continue due to concerns about deflation.

However, it is important to be aware of the effect that the Fed’s policy change will have on the world. There are fears that, if U.S interest rates rise and the purchasing power of the dollar grows, emerging markets will bleed out capital, which will lead to currency depreciation.

Japan cannot wait out the fire raging on the opposite shore. The potential strengthening of the dollar as the yen depreciates and import prices increase, coupled with a rise in crude oil prices, could be a blow to Japan’s economy, which has been slow to recover.

The Fed should be cautious about causing confusion in the world, and strive to normalize monetary policy. It should assess both domestic and international economic climates before making judgments not only about the pace at which to reduce quantitative easing, but also regarding increasing interest rates.

Last March, the Fed introduced two plans to help the U.S. economy through the COVID-19 pandemic. One was the quantitative easing policy to buy into the U.S. Treasury and other entities; the other introduced a near 0% interest rate to inject funds into the financial market. It was an exceptionally large-scale plan to support the economy during the pandemic.

Regarding quantitative easing, the monthly asset purchase amount of $120 billion (approximately 13.7 trillion yen) will be gradually reduced. If the economy continues to recover, asset purchasing will end around the middle of next year.

The Fed will maintain another 0% interest policy for the time being. The Fed has determined that it is too early to begin tightening monetary policy and raising interest rates, but it will have to make the difficult decision of when to raise interest rates.

The Fed can’t allow inflation to increase by delaying interest rates too long, but it must also not cause the economy to stumble by moving too quickly. Price increases in the United States are partly due to supply limitation and the difficulty procuring raw materials, as well as the logistical problems that have accompanied the pandemic. It should be carefully determined how long this will last. Fed Chair Jerome Powell should continue to be transparent about these issues.