US Economic Update: ‘sterilized’ QE
If the Fed undertakes another round of Quantitative Easing it may be ‘sterilized’. That is, the Fed would ensure there […]
- If the Fed undertakes another round of Quantitative Easing it may be ‘sterilized’. That is, the Fed would ensure there is no increase in bank reserves, either
- through using reverse repurchase agreements or auctioning term deposits to banks.
- Reverse repos or term deposits are a form of shortterm borrowing. Under unsterilized QE, the asset purchases were funded by creating bank reserves. As bank reserves are part of base money many viewed this as ‘printing money’. However, the Fed now pays interest on bank reserves and so under either ‘sterilized’ or unsterilized QE the asset purchases would be funded by short-term borrowing.
- ‘Sterilized ‘QE would affect the economy in a similar way to unsterilized QE, primarily through lowering longer-term interest rates. This directly encourages economic activity and can also boost other asset markets such as equities, improving wealth, and also places downward pressure on the currency.
- With the mechanism by which sterilized or unsterilized QE affects the economy not that different, the main reason the Fed might ‘sterilize’ any future QE is to address concerns that it is akin to printing money and, ultimately, highly inflationary. While the view that QE will prove inflationary through a simple money multiplier process is unwarranted, expectations of inflation can matter. Therefore, the Fed may see ‘sterilized’ QE as a means of helping to keep inflation expectations under control.
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