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Fed Expects Five to Eight Years to Shrink Balance Sheet If No More QE

by on May 9, 2014 3:54 am BST
 

Federal Reserve chair Janet Yellen told the Senate Finance Committee, during the second day of her Congressional hearing, which if the central bank decided to shrink its balance sheet that it would take roughly five to eight years to do so. Prior to the financial crisis, the Fed balance sheet was $800 billion in 2007. Now, the balance sheet has expanded to roughly $4.5 trillion – with a “t.”

In last month’s FOMC minutes report, the Fed said that it seen “momentum” in the economy and that a sustained recovery is in reach. However, during day one of the Congressional hearing, Yellen said that housing (one of the bright spots of current grow) expansion was deteriorating and needed to be watched carefully. Data this week showed that new home ownership in the United States is almost at a 20-year low. She, also, said that near-zero interest rates were needed until the recovery strengthens and the labor market picks up.

The Fed chair was unable to tell the Senate committee when the unwinding of the balance sheet would take place. “We’ve not decided, and we’ll probably wait until we’re in the process of normalizing policy to decide, just what our long-run balance sheet will be,” said Yellen. It would be “substantially lower” than it is now, she added. She does not know when it would unwind the balance sheet, yet she knows that it will be lower than current levels? Unfortunately, Fed “guidance” has become a growing contradiction. 

Yellen assumes that if the Fed did nothing more, it would take roughly eight years to unwind the five years of quantitative easing. However, it is uncertain whether or not the Fed will continue asset purchases in the future. After QE1, there was QE2, then there was Operation Twist, and now the current mortgage-backed securities plus bond purchasing program that went from $85 billion per month to the current level of $45 billion. If the Fed’s economic momentum thesis after a .1 percent prelim GDP figure does not hold true, there is no stopping the Fed from another round of quantitative easing. The Fed is in a QE trap; and some are afraid that if rates rise inflation would unleash unholy havoc on the American people.