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In a new note, Spyros Andreopoulos
at Morgan
Stanley takes a big picture look at central bank balance sheets, and what he
calls the "coming of age" of QE.
Whereas at first, central banks use
their balance sheets surgically -- e.g. unthawing specific markets -- it's not
the dominant strategy for the Fed, the Bank of Japan, the Bank of
England, and the ECB to expand their balance sheets broadly at any sign of
trouble or deflation.
It's now to the point where there collective balance sheets are nearing 36%
of GDP.Andreopoulos writes:
Normative considerations aside, what will actually
happen? Central bank balance sheets are likely to remain bloated for a long
period of time – indeed, the balance sheet expansions might even end up being
quasi-permanent.
First, even if all goes smoothly and the recovery proceeds slowly but surely, it will probably take central banks many years to exit, even if you discount the fiscal dominance argument. Asset sales would have to proceed with the utmost caution – indeed, risk-aversion implies that central banks would rather err on the side of caution and sell too little, too late – just one of the reasons why we are worried about inflation in the long term. Second, if (i) the recovery remains bumpy, with more growth scares; and/or (ii) we revert to recession at some point over the next few years, it seems almost certain that balance sheets will be deployed again. So, in the near-to-medium term, the only way for balance sheets seems to be up. Finally, because of the possibility of economic shocks, the unwind of balance sheets might even take the shape of ‘two steps forward, one step back’. That is, unless we are wrong in the above and balance sheets can indeed be reduced rapidly, a balance sheet reduction that’s on the way could be interrupted by a large deflationary shock, which necessitates renewed expansion, and so on.
First, even if all goes smoothly and the recovery proceeds slowly but surely, it will probably take central banks many years to exit, even if you discount the fiscal dominance argument. Asset sales would have to proceed with the utmost caution – indeed, risk-aversion implies that central banks would rather err on the side of caution and sell too little, too late – just one of the reasons why we are worried about inflation in the long term. Second, if (i) the recovery remains bumpy, with more growth scares; and/or (ii) we revert to recession at some point over the next few years, it seems almost certain that balance sheets will be deployed again. So, in the near-to-medium term, the only way for balance sheets seems to be up. Finally, because of the possibility of economic shocks, the unwind of balance sheets might even take the shape of ‘two steps forward, one step back’. That is, unless we are wrong in the above and balance sheets can indeed be reduced rapidly, a balance sheet reduction that’s on the way could be interrupted by a large deflationary shock, which necessitates renewed expansion, and so on.
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