The reduction in assets on the balance sheet of the Fed frightens many investors and analysts. In their opinion, this could lead to a collapse of the world’s stock markets. Why are these fears groundless and what can the Russian authorities learn from the Fed?
In the fourth quarter of 2017, the US Federal Reserve System began to reduce financial assets on its balance sheet – bonds of the US government and mortgage agencies that were purchased from 2008 to 2014 as part of a quantitative easing (QE) program. The American regulator will sell these securities much more slowly than it bought: in the next three years the Fed will get rid of assets for $ 2.2 trillion.
Nevertheless, many media and analysts say that the Fed, like a giant pump, will begin to pump out a huge dollar mass pumped in during the 2008 crisis, and this could lead to a collapse of the US stock market. As experience shows, the Russian market is very sensitive to the mood in the US, and in case of significant correction at US sites, the Russian market is waiting for an even greater decline.
Let’s figure out what the Fed actually does and why horror stories about the negative impact of its policies on the market do not correspond to reality.
Securities purchases within the QE American regulator held in three rounds. Many analysts then argued that the dollar was about to collapse because of the continuous operation of the printing press, the US is waiting for hyperinflation, and the stock markets – a collapse. But nothing like this happened. The main reason is the lack of a direct link between the “printing” of the Fed’s money and the amount of money in the real sector of the economy.
The central bank buys bonds of the government and quasi-state structures from commercial banks, which, in turn, buy similar securities from their clients (pension funds, individuals, etc.).
The money received from the sale of bonds is placed by investors in their banks, and banks in turn place money on the reserve accounts of the Central Bank (special accounts reflecting the CB’s obligations to these banks). Thus, the Central Bank increases the monetary base, but this does not imply an automatic increase in the amount of money in the economy, since the monetary base is not equal to the money supply.
The money supply (includes loans to the economy, cash in cash and on accounts) is basically the result of the credit activity of the banks themselves. The absence of direct correlation between the growth of the monetary base and the money supply M2 proves the historical dynamics of the ratio of the money supply M2 to the monetary base in the USA.
The ratio of the money supply M2 to the monetary base from 1959 to 2007 varied in the range from 5.7x to 11.7x, the growth of the money supply M2 over this period exceeded the growth of the Fed reserves by 1.6 times.
However, the quantitative easing program of 2008-2014 significantly changed the money multiplier. The growth of reserves from $ 1.1 trillion to $ 4 trillion did not lead to explosive growth of money supply, and the multiplier decreased from 7.0 to 2.9x and has not returned to its historical values to date.
The growth of reserves (and, consequently, of the monetary base) has no direct relationship with the increase in the money supply. The size of banks’ reserves in the Central Bank can only indirectly stimulate lending to companies and the public through lower interest rates.
So in practice, the impact of the policy of the Fed on the credit activity of banks was small. Banks did not begin to issue new loans from funds on reserve accounts in the Fed. First, credit institutions did not see new solvent borrowers, and secondly, they did not spend new money from selling bonds of customers and securities from their portfolio in order to increase the stability of their own bank balance in the event of a new crisis.
Based on the experience of the Fed on QE, it can be confidently asserted that the sale of previously bought bonds will not lead to a reduction in the money supply and the fall of the US stock market, just as the purchase of bonds in 2008-2014 did not lead to hyperinflation.
Reducing the balance of the Federal Reserve and other central banks of the world will not have a catastrophic impact on the global market. The process, the inverse QE, is as safe as the QE itself. Investors will return to the bonds, the reserves of commercial banks in the Central Bank will decrease, the money supply will continue to grow under the influence of other macroeconomic factors.
Will the experience of the Fed in Russia?
In recent years, a number of experts have repeatedly raised the topic of quantitative easing for Russia. In their opinion, the presence of a large amount of cheap money will help to solve the problem of low economic growth in Russia.
But a simple solution is not always correct. Even in developed countries, the impact of QE on the volume of lending to the real sector of the economy is small. For developing economies, such as Russia, the effect of the buyout program will be negative for a number of reasons. Among them are the following.
- Weak development of the government bond market in Russia, through which QE programs are mainly implemented in developed countries.
- The undeveloped financial market as a whole, a small set of available financial instruments, low liquidity in the markets. Investors simply have nowhere to invest in Russia, and new rubles will pour into the foreign exchange market with the further aim of investing in foreign markets.
- In Russia, an increase in the monetary base does not directly affect the money supply, but it significantly accelerates the price increase. For the growth of the money supply and active lending to the real sector, banks need good borrowers and economic stability, and not cheap money. Banks themselves in the conditions of economic growth “create money” through a bank multiplier – just as much as necessary. A simple “printing money” on the part of the Central Bank of the Russian Federation in conditions of low confidence in state institutions and the national currency will only cause devaluation and a rise in prices.
- The large lobbying opportunities of state companies that make up more than half of the country’s economy will lead to direct financing of state companies through the repayment of their bonds by the Central Bank. Such mechanisms will stimulate inefficiency of state-owned companies due to the “inflation tax” on the population and private companies.
Thus, QE is not an actual tool at the current stage of development of the Russian economy. It is much more important for the country to reduce the share of the public sector, to protect fair competition in the markets (including between state and private companies), to develop the financial market, and to ensure the immutability of the “rules of the game.” Such measures will lead to an increase in investment activity in the country, increase the confidence of economic agents in the state, will cause more lending to the economy by banks and sustained qualitative GDP growth.
Author: Mikhail Trophimov, UCP
Article in Russian: Forbes