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Question 1021 Federal funds rate, monetary policy, quantitative easing, tapering

US Fed Chair Jerome Powell held a news conference following the 25-26 January 2022 FOMC meeting.

Nick Timiraos reporting for The Wall Street Journal asked: "Raising rates and reducing the balance sheet both restrain the economy, both tighten monetary policy. How should we think about the relationship between the two? For example, how much passive runoff is equal to every quarter percentage point increase in your benchmark rate?"

Jerome Powell replied: "So, again, we think of the balance sheet as moving in a predictable manner, sort of in the background, and that the active tool meeting to meeting is not -- both of them, it's the federal funds rate. There are rules of thumbs. I'm reluctant to land on one of them that equate this. And there's also an element of uncertainty around the balance sheet. I think we have a much better sense, frankly, of how rate increases affect financial conditions and, hence, economic conditions. Balance sheet is still a relatively new thing for the markets and for us, so we're less certain about that." (US Fed, 2022)

When Nick Timiraos mentioned 'reducing the balance sheet', he's referring to:

(a) Quantitative easing (QE), where the US Fed increases its asset purchases. For example, by buying more US government bonds each month, increasing demand for bonds, raising their price and lowering their yield.

(b) Tapering, where the US Fed decreases its asset purchases. For example, by buying less US government bonds each month, decreasing demand for bonds, lowering their price and raising their yield.

(d) Contractionary conventional monetary policy, where the US Federal Reserve lowers the Fed funds rate.

(e) Expansionary non-conventional monetary policy, where the US Federal Reserve reduces its assets through the purchase of more US government bonds, increasing the US Federal Reserve's liabilities.

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