For release on delivery
10:15 am. EST
March 1, 2024

Thoughts on Quantitative Tightening, Including Remarks on the Paper
"Quantitative Tightening around the Globe: What Have We Learned?"

Remarks by
Christopher J. Waller
Member
Board of Governors of the Federal Reserve System
at the
2024 U.S. Monetary Policy Forum

New York, New York

March 1, 2024

Thank you, it is great to be here. I'm pleased to participate in this panel to discuss
a policy action now being implemented by central banks around the globe: quantitative
tightening (QT).! I want to thank Kristin, Matt, and Wenxin for putting together a great
paper that provides an overview of the effects of QT across seven central banks.

Often called "large-scale asset purchases" (LSAPs) by central bankers, the view
of quantitative easing, or QE, as a tool to add monetary policy accommodation and QT to
tighten policy has changed over time. When it was used during and after the Global
Financial Crisis, QE was deemed an "unconventional" tool in central banks' arsenals.
But QE has now been used numerous times in the past two decades for extended periods
when the policy rate was at the effective lower bound, so I would say it is no longer
unconventional.

Given the role of QE and QT in the policy toolkit, it is good to have researchers
and policymakers examine how asset purchases work and talk about current issues
associated with their implementation. This paper is very timely and thorough in looking
across countries and their experiences with QE and QT. There is a lot packed into this
work that makes it a little difficult to fully assess in the time we have today. So I will
focus my comments on four points: (1) the evidence that the effects of QE are
asymmetric to the effects of QT; (2) the execution of QE versus the execution of QT in
the United States; (3) the role of announcement effects of QT; and, finally, (4) who has
taken the Fed's place in buying assets when we withdraw from the market. I will then
end with some thoughts about issues facing the Federal Reserve as we move forward with

normalizing our balance sheet.

' The views expressed here are my own and are not necessarily those of my colleagues on the Federal Open
Market Committee.

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The Asymmetry of Quantitative Easing versus Quantitative Tightening

For me, one of the most interesting results of the paper is that the announcement
effects of quantitative easing are much larger than the announcement effects of
quantitative tightening. The authors find that announcements of QT have a small but
statistically significant effect in increasing government bond yields-about 4 to 8 basis
points. But this effect is much smaller, in absolute terms, than the prevailing estimates of
the decrease in yields from announcements of QE. The conclusion is that the interest rate
effects of QE and QT are asymmetric. For an economist, this result may seem
puzzling-why would changing the sign on an action lead to asymmetric effects on
prices and real variables?

Ever since central banks initiated QE in response to the Global Financial Crisis,
academics have debated its effectiveness. One view is that it has a very limited effect in
situations where a central bank is swapping zero interest-bearing reserves for zero
interest-bearing shorter-term Treasury securities. Because the two assets would seem to
be nearly perfect substitutes, there can be no price effects from altering the composition
of the two assets. The central bank is simply swapping two $10 bills for a twenty. If this
is true, then undoing the trade via QT has no effect either. It should be symmetrical.

The alternative view, based on market segmentation or preferred habitat theory, is
that when a central bank uses reserves to pay for government securities, it is decreasing
the supply of these securities to private investors, which will bid up the price and lower

the interest rate on government securities.? By lowering interest rates on longer-maturity

? There are several theories for how QE works. The market segmentation theory suggests that assets of
different maturities are imperfect substitutes, so a lower supply of long-term assets and a higher supply of
short-term assets would imply that long-term interest rates fall and short-term interest rates rise. The

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assets, which pay a higher interest rate than reserves, the central bank can stimulate the
economy in a manner similar to lowering the policy rate. But by this logic, when QT
reverses QE, asset prices should fall and yields should rise in equal magnitude. Thus, any
positive effects derived from QE would be reversed when QT occurs. This suggests that
QE and QT may cancel each other out in welfare terms. But if there are no net benefits
from the action, what is the point of doing it? To illustrate this point, suppose someone is
given a weight-loss drug and they lose 80 pounds, but then the drug is taken away and
they regain the 80 pounds. What was the point of the exercise if there was no net welfare
gain?

To me, for QE to be beneficial on net, there has to be asymmetry in the effects of
QE relative to QT. My thinking on this has long been guided by the conclusions of a
paper I wrote with Alex Berentsen about optimal stabilization policy, which is what QE
and QT ultimately should be about.? The gist of the argument is that when shocks and
frictions to trading arise suddenly, the central bank can take actions such as injecting
reserves to ease trading frictions or credit constraints and improve welfare. But by
waiting until the frictions and shocks dissipate before undoing the injections, the positive
effects are not reversed. As an example, when a house is on fire, pouring water on the
fire will put it out, which has great benefits for all. But when the fire is out, draining the
water away does not reignite the fire-the initial benefits are not undone. The punchline

here is that QE is conducted under different market conditions than those that occur when

preferred habitat theory suggests that financial market participants prefer certain asset maturities over
others and the price (or interest) rate needs to adjust to change their desired mix of holdings.

3 For details of the model and results, see Aleksander Berentsen and Christopher Waller (2011), "Price-
Level Targeting and Stabilization Policy," Journal of Money, Credit and Banking, vol. 43, Supplement 2
(October), pp. 559-80.

4.

QT is done, so it is not surprising that the effects will be different. The authors' findings
that QE has asymmetric effects compared to QT is not a puzzle but an indication that
central banks timed QE and QT in the right manner such that society was better off.

The Execution of Quantitative Easing versus Quantitative Tightening

Turning to the impact of QE and QT on interest rates, analysis often focuses on
the term premium. There are three key elements of asset purchases that change the term
premium: (1) the expected path of QE, which includes the amount and timing of
purchases; (2) the length of time the central bank is expected to hold the additional
securities; and (3) the expected path of QT, including the amount and timing of
redemptions, which importantly depends on the desired ultimate size of securities
holdings (and reserve balances) of the central bank. As soon as an asset purchase
program is announced, these expectations are formed, resulting in the term premium
effect, or TPE, on interest rates.

Over time, the TPE will change, based on both the passage of time and any
updates to the public's expectations for the components I just mentioned. Let me talk
about three factors that affect both the expected path of asset purchases and interest rates.
These factors are things to keep in mind for future policy decisions.

First, there are two ways that QE can be implemented, and they have different
impacts on interest rates. These are what I call closed- or open-ended QE programs.
Closed-ended QE programs involve an announcement of a fixed stock of purchases over
a fixed period of time. An example of this type of asset purchase program was initiated

by the Fed in March 2009.* Open-ended QE simply gives a purchase amount per month

4 An example of a closed-ended program is from March 2009, when the Federal Open Market Committee
(FOMC) noted that "to help improve conditions in private credit markets, the Committee decided to

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but no calendar endpoint, so the expected size of the program is unspecified. A set of
economic conditions for reducing or ending purchases may be stipulated, but when they
will occur is not perfectly predictable. Here, one can think of the Fed's most recent asset
purchase program.

At the time of an asset purchase announcement, it will be easier for markets to
fully price in a closed-ended program, since its purchase amount and end date are given,
whereas the open-ended program's pricing will depend on market expectations for the
evolution of the economy. So if one wants a particular impact on interest rates at the
announcement date, one might lean toward a closed-ended program or be aware that
additional guidance on the expected path of the open-ended program will be needed.

As time passes and the economy evolves, the two programs work differently.

One might prefer an open-ended program over time because it dynamically responds to
the evolution of economic conditions. The program could be halted or extended as
conditions improve or worsen, unlike a closed-ended program. But, of course, the
criteria set in the open-ended program must be carefully considered. As I said in a recent
FEDS Note and in several speeches, the 2020 criteria for when to begin QT may have

been too restrictive and did not allow the Committee to taper as soon and as gradually as

purchase up to $300 billion of longer-term Treasury securities over the next six months"; see paragraph 3
of the March 2009 FOMC statement, which is available on the Board's website at
https://www.federalreserve.gov/monetarypolicy/fomecalendars.htm. An example of an open-ended
program is from December 2020, when the FOMC stated it would keep buying $120 billion per month in
securities "until substantial further progress has been made toward the Committee's maximum employment
and price stability goals"; see paragraph 4 of the December 2020 FOMC statement, which is available on
the Board's website at https://www.federalreserve.gov/monetarypolicy/fomccalendars.htm.

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desired.> Setting the appropriate criteria ahead of time to create the flexibility needed to
respond to changing economic and financial conditions is very hard to do.

The second factor affecting the path of asset purchases is that it is very important
that QE be credibly followed by QT. If QE is viewed as nothing more than a permanent
injection of money into the economy, it would likely create inflation. This was widely
predicted back in 2009, but the inflation didn't happen. Why? In my view, it didn't
happen because the Fed credibly committed to withdrawing the injected reserves at a
later date. Pre-committing to QT is what allows the injection of reserves into the
economy without inflation or other longer-run distortions of market pricing. So when
starting asset purchases or weighing how to approach asset runoff or sales, it is important
that the central bank commit to normalizing its balance sheet.

The third factor is that it is important for a central bank to move carefully as it
comes to the end of QT and the desired level of ample reserves. The endpoint should be
related to the expectation of the banking system's demand for reserves. In the United
States, we saw stresses in money markets in the fall of 2019, when the Fed reduced the
level of reserves during balance sheet normalization through July and then there was
heavy issuance of Treasury securities in September. The level of reserves likely went a
bit too low.® Learning from our experiences and trying to understand how the demand

for reserves has changed over time suggests moving carefully toward the endpoint of QT.

5 See Jane Ihrig and Chris Waller (2024), "The Federal Reserve's Responses to the Post-COVID Period of
High Inflation," FEDS Notes (Washington: Board of Governors of the Federal Reserve System, February
14), https://doi.org/10.17016/2380-7172.3455.

6 For a discussion of the September 2019 experience, see Sriya Anbil, Alyssa Anderson, and Zeynep
Senyuz (2020), "What Happened in Money Markets in September 2019?" FEDS Notes (Washington:
Board of Governors of the Federal Reserve System, February 27), https://doi.org/10.17016/2380-
7172.2527.

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For this reason, even if QE is an open-ended program, QT is more likely to
resemble a closed-ended program. Central banks usually have an idea of how large they
want their balance sheet to be when QT ends; therefore, once the pace of QT is
announced, markets should be able to effectively price in the entire program at the
announcement of the plan. After that, the actual execution of QT is simply validating the
beliefs that market participants had at the announcement. This is why many refer to QT
as merely draining unneeded reserves, which should be as interesting as watching paint
dry.

Quantitative Tightening in the United States

Let me now turn more directly to the authors' paper and two of their findings.
First, as I mentioned earlier, they find central banks' QT announcements have only a
small effect on interest rates. To conduct this analysis, the authors do an event study
around QT announcements, which requires them to identify "surprises" in the QT
announcements. As the authors acknowledge, this is not a trivial exercise. My comment
here is to point out why identifying a QT announcement surprise is challenging when
considering examples in the United States.

Let me walk through the evolution of the Fed's QT communications in the spring
of 2022 to consider how various communications affected the expected path of QT.'

Recall that QE ended in March 2022.° Heading into April, it was likely that markets

7 Prior to the spring announcements, the Federal Open Market Committee (FOMC) began discussions on
policy normalization as reported in the December 2021 FOMC minutes. It was noted that some
participants observed that the balance sheet could potentially shrink faster than the previous experience.
The 10-year Treasury yield moved up several basis points around the release of the minutes.

8 In March 2022, the Federal Open Market Committee (FOMC) indicated that it "expects to begin reducing
its holdings of Treasury securities and agency debt and agency mortgage-backed securities at a coming
meeting"; see paragraph 3 of the March 2022 FOMC statement, which is available on the Board's website
at https://www.federalreserve.gov/monetarypolicy/fomccalendars.htm. This language signaled the Fed

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expected a redemption path somewhat like the Fed's 2017-2019 QT plan.? That plan
phased in redemptions over 12 months and ultimately allowed, at most, $30 billion of
Treasury securities and $20 billion of agency mortgage-backed securities (MBS) to be
redeemed each month. On April 5, 2022, then-Vice Chair Lael Brainard gave a speech
that noted the balance sheet would shrink considerably more rapidly than in the previous
case of QT; specifically, she said that "significantly larger caps and a much shorter period
to phase in the maximum caps compared with 2017-2019."!° The next day, the Federal
Open Market Committee (FOMC) minutes provided additional information on the
expected maximum monthly caps and phase-in period, saying participants generally
agreed to a three-month phase-in and caps of $60 billion and $35 billion for Treasury
securities and agency MBS, respectively.

Over those two days in April, the markets likely updated their expected QT plans
to have sooner and larger redemptions. This change would be associated with a less
negative term premium effect, meaning a rise in Treasury yields. The 10-year Treasury
yield rose 19 basis points over the two days of the Vice Chair's speech and the FOMC
minutes-that is, 12 basis points on the day of her speech and another 7 basis points on

the day of the FOMC minutes-and a total of 37 basis points over that week.

would be holding the peak amount of securities on its balance sheet for just a short period of time, which
turned out to be between March and the end of May.

° In January 2022, the Federal Open Market Committee provided a statement on "Principles for Reducing
the Size of the Federal Reserve's Balance Sheet," but it did not provide information about the timing or
pace of redemptions; the statement is available on the Board's website at
https://www.federalreserve.gov/newsevents/pressreleases/monetary20220126c.htm.

'0 See Lael Brainard (2022), "Variation in the Inflation Experiences of Households," speech delivered at
the Spring 2022 Institute Research Conference, Opportunity and Inclusive Growth Institute, Federal
Reserve Bank of Minneapolis, Minneapolis, April 5,
https://www.federalreserve.gov/newsevents/speech/brainard20220405a.htm.

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About a month later, on May 4, 2022, the FOMC communicated its "Plans for
Reducing the Size of the Federal Reserve's Balance Sheet." The plan was consistent with
the FOMC minutes from April, and there was little change in the 10-year Treasury yield
that day and week (negative 4 basis points on the day of the announcement and 2 basis
points over the five-day period). So, when doing event studies, it may be difficult to
estimate the full impact of QT announcements by simply looking at the formal
announcement of the QT plan.

Let me turn to a second point of the paper, about which types of investors have
increased their securities holdings as the Fed has reduced its holdings. When a central
bank steps away from asset purchases and begins to shrink its balance sheet, a common
question is, who will step in and take the central bank's place in buying securities? I
always respond by saying, "Why is this important?" Ifthe government bond market is
broad and deep, there will be plenty of buyers-there is no need to worry about who will
buy the government debt. If the government bond market is not broad or deep, however,
then the central bank's actions can have adverse and unwanted effects on prices and
market functioning. This would then affect how fast the central bank can reduce its
balance sheet and whether it can do so passively or actively.

One could also argue that it matters because knowing the buyers helps one
understand the transmission of QT to asset prices and interest rates. Does it matter if it is
banks or nonbank financial firms that are doing the buying? Does it matter if it is hedge
funds, pension funds, or actual households doing the buying? One needs to have a better
understanding of why the question is being asked before one can fully understand the

answers to the question.

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The authors focus on the reduction in aggregate securities holdings of central
banks and find that households and broker-dealers are the main investors absorbing the
redeemed securities. For my discussion today, I decided to dig a bit deeper into the
Financial Accounts of the United States in two ways. First, I decided to look at each type
of security (Treasury securities and agency MBS) individually.!! For Treasury securities,
I also find that since the 2022 start of QT, households have boosted their market share the
most, and broker-dealers have also increased their share. For agency MBS, not only has
the market shares of those two investor types increased, but so has the market shares of
money market funds.

Second, I dug into the household category a bit more. As currently categorized,
the Financial Accounts household category includes hedge funds. The Federal Reserve
Board is working to segregate hedge funds in this data set. In the interim, the Board
publishes separate data on the balance sheets of domestic hedge funds.'? Using this
supplemental data, I find that it is not the hedge funds that are responsible for the increase
in household market share. This means the increase is driven by the other household
investors: actual households and nonprofit organizations.

What do I make of this finding? My interpretation is that it reinforces the view
that the demand for U.S. Treasury securities is broad and deep-the buyers are not a
narrow set of deep-pocketed, sophisticated investors but rather the American public. As

a result, the pace of runoff is not a problem. As we have seen with the current phase of

"I My calculations look at how investor types' market shares change over time, as is done in Seth
Carpenter, Selva Demiralp, Jane Ihrig, and Elizabeth Klee (2015), "Analyzing Federal Reserve Asset
Purchases: From Whom Does the Fed Buy?" Journal of Banking and Finance, vol. 52 (March), pp. 230-
44.

'2 Data on the balance sheet of hedge funds is available on the Board's website at
https://www.federalreserve.gov/releases/z 1/2023 1207/html/b101f.htm.

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QT, runoff up to $95 billion a month is not causing substantial strains in financial
markets-something that a few years ago would have surprised a lot of people, given the
worries about QT that were common prior to 2022.

Normalization

Let me conclude with a few comments on where I believe the Fed should be
heading as it continues to normalize its balance sheet. By "normalizing" I mean reducing
the size of the balance sheet but retaining enough assets to manage monetary policy using
an ample-reserves regime.

As the Federal Reserve continues its QT program, I support further thinking about
how many more securities to redeem. We have an overnight reverse repurchase
agreement facility with take-up of more than $500 billion, and I view these funds as
excess liquidity that financial market participants do not want, so this tells me that we can
continue to reduce our holdings for some time.

In addition, it is important to remember that we now have a standing repurchase
agreement facility (SRF). The SRF serves as a backstop in money markets, since it takes
in Treasury securities as well as agency MBS and puts reserves in the banking system.
This facility may allow banks to lower the level of reserves below what reserves would
be without the facility, and it may provide a signal for when reserves are getting close to
ample.

Chair Powell has noted that the FOMC will begin to discuss slowing our
redemptions at our FOMC meeting this month, which will help us transition into
whatever definition of "ample" we deem appropriate. Changing our pace of redemptions

will occur when the Committee makes a decision to do so, and the timing will be

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independent of any changes to the policy rate target. Balance sheet plans are about
getting liquidity levels right and approaching "ample" at the correct speed. They do not
imply anything about the stance of interest rate policy, which is focused on influencing
the macroeconomy and achieving our dual mandate.

Thinking about longer-term issues related to the Fed's portfolio, I want to
mention two things. First, I would like to see the Fed's agency MBS holdings go to zero.
Agency MBS holdings have been slow to run off the portfolio, at a recent monthly
average of about $15 billion, because the underlying mortgages have very low interest
rates and prepayments are quite small. I believe it is important to see a continued
reduction in these holdings.

Second, I would like to see a shift in Treasury holdings toward a larger share of
shorter-dated Treasury securities. Prior to the Global Financial Crisis, we held
approximately one-third of our portfolio in Treasury bills.!? Today, bills are less than 5
percent of our Treasury holdings and less than 3 percent of our total securities holdings.
Moving toward more Treasury bills would shift the maturity structure more toward our
policy rate-the overnight federal funds rate-and allow our income and expenses to rise
and fall together as the FOMC increases and cuts the target range. This approach could
also assist a future asset purchase program because we could let the short-term securities
roll off the portfolio and not increase the balance sheet.'* This is an issue the FOMC will

need to decide in the next couple of years.

'3 A Treasury bill is a security backed by the U.S. Treasury Department with a maturity of up to 52 weeks.
A bill is sold at a discount, and at maturity the investor receives the par value of the security.

'4 There may be other considerations for holding a sizable share of bills in the Fed's portfolio. For
example, Vissing-Jorgensen (2023) argues for considering the convenience yield impact of bills; see
Annette Vissing-Jorgensen (2023), "Balance Sheet Policy above the ELB," paper presented at the ECB
Forum on Central Banking, held in Sintra, Portugal, June 26-28.

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In conclusion, let me be clear that this is a great paper that will serve as a major
reference for researchers and central banks. The authors' analysis will surely have a

much longer shelf life than my discussion of it.