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Quantitative Tightening: Protecting Monetary Policy from Fiscal Encroachment

Author

Listed:
  • jagjit Chadha
  • William Allen
  • Philip Turner

Abstract

As we face up to the need to plan an eventual exit from quantitative easing, in this Commentary we consider how to reform both sides of the central bank balance sheet in a manner that will prepare the ground for a contraction in the balance sheet that does not expose the central bank to excessive risk. Post-QE central bank balance sheets have a maturity mismatch, with long term bonds as assets financed by liabilities in the form of commercial bank reserves bearing floating interest rates. In a central bank balance sheet contraction – quantitative tightening – the private sector will be asked to absorb those assets, which may place abrupt upward pressure on the yield curve. If policy interest rates rise, the interest cost of the central bank's liabilities will rise quickly while the interest income from its assets rises only slowly. Prompt and timely moves to reduce the mis-match by reducing the duration of assets and increasing that of liabilities will limit both the financial risks to the central bank and the risk of disruption to bond markets.

Suggested Citation

  • jagjit Chadha & William Allen & Philip Turner, 2021. "Quantitative Tightening: Protecting Monetary Policy from Fiscal Encroachment," National Institute of Economic and Social Research (NIESR) Policy Papers 27, National Institute of Economic and Social Research.
    • Handle: RePEc:nsr:niesrp:27
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    References listed on IDEAS

    as
    1. Chadha, Jagjit S. & Corrado, Luisa & Meaning, Jack & Schuler, Tobias, 2021. "Monetary and fiscal complementarity in the Covid-19 pandemic," Working Paper Series 2588, European Central Bank.
    2. Joseph E. Gagnon, 2016. "Quantitative Easing: An Underappreciated Success," Policy Briefs PB16-4, Peterson Institute for International Economics.
    3. Philip Turner, 2021. "The New Monetary Policy Revolution: Advice and Dissent," National Institute of Economic and Social Research (NIESR) Occasional Papers 60, National Institute of Economic and Social Research.
    4. William Allen, 2021. "Managing the Fiscal Risk of Higher Interest Rates," National Institute of Economic and Social Research (NIESR) Policy Papers 25, National Institute of Economic and Social Research.
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