The economist John Taylor came to Minneapolis this week to deliver a message that monetary policy needs to become more stable, rules-based and predictable.
Taylor, a Stanford University economist so well known he has an economic principle named after him, told the Economic Club of Minnesota gathering that monetary policy in the last 15 years has come to resemble the bad old days of the 1960s and 1970s, with policy moves he called “discretionary.”
While making clear that policymakers at the Federal Reserve used a lot of wisdom and courage to boost liquidity in the financial markets after the credit crisis of 2008, he also has been pretty pointed in his criticisms of the Fed since then.
We sat down briefly after his talk to discuss something he didn’t really discuss at length, and that’s the current size of the Fed’s balance sheet.
The Federal Reserve is still a bank, of course, and it does have a balance sheet. Ten years ago the Fed’s total assets were less than $850 billion.
After the financial crisis, and then three separate programs of buying securities known as quantitative easing, the Federal Reserve’s balance sheet ballooned to $4.5 trillion, about where it stands as of the end of the most recent quarter.
The Fed now owns $2.6 trillion of U.S. Treasury securities and about $1.8 trillion of federal agency and government-sponsored enterprise mortgage-backed securities. It’s easy to accumulate that many bonds with a program of monetary stimulus that as recently as two years ago meant buying $85 billion worth of securities a month.
As Taylor pointed out, there’s nothing “normal” about a central bank balance sheet that big. “Ultimately, they need to get the balance sheet down,” he said.
The smart thing to do would be some selling but only gradually, he said, as selling means taking money out of the financial system, a form of monetary tightening.
It’s an interesting and valid point he’s making.
Without any action at all, having a huge balance sheet will increasingly look normal to monetary policymakers, at the Fed and other central banks. As brilliant as these people are, it just may become easier to forget that the Fed’s balance sheet only got that big because of an unprecedented and extraordinary program of buying securities to stimulate the economy.
And having an extraordinary policy become normal is the last thing we need.