Zero Equilibrium on Fed President Williams on the Conventional Use of Balance Sheet Intervention
Pointing to “economic research that describes how policies like asset purchases can be effective even when short-term rates are very low”¹, the New York Fed President asserts that the balance sheet expansion in the wake of the 2008 financial crisis was anything but unconventional, as some economists argue.
“These are not ‘emergency,’ ‘crisis’ or ‘break-the-glass’ policies, but those that are well within the long tradition of monetary theory and practice,”¹ –Williams on @Bloomberg @markets
He says that, “how and when to use policies depends on the circumstances and the risks policymakers are facing,”¹. However he says ”this is a matter of tactics and implementation, not of principle or strategy.”¹
ZE Remarks on Fed's John Williams Assertions:
Prior to the 2008-2014 QE cycle, there has been more validates Williams case, and mirrors Zero Equilibrium's @Muhammad_Okoye's thinking.
See the rundown of policies below giving credence to this assertion, by showing the historical use of balance sheet by different central banks from the 1930s through to 2006.
Williams’s claim that balance-sheet tools are within the long tradition is supported by repeated historical use is spot on, and goes back to the 1930s through to the 1960's, the 1970s and and 1990s and more recently Bank of Japan's 2001 - 2006.
Post 1929 Great Depression:
After the 1929 crash and banking crises, short-term rates approached the lower bound (~0.25% by 1932). This was due to expansionary monetary policy response as the Fed undertook between 1932-1936, with large purchases of U.S. Treasuries (“outright open market purchases”), injecting reserves into the banking system.
These purchases helped stabilize banking reserves, support the money supply, and reduce long-term rates. And Friedman & Schwartz (1963) identify them as important in halting deflationary pressures.
Operation Twist (1961, Kennedy Administration):
In response to yet another financial markets instability, the Fed and Treasury coordinated to flatten the yield curve, this they did by purchasing long-term Treasuries while selling short-term bills (“twisting” the maturity profile, so to speak). This had the effect of raising/stabilizing short-term yields.
The objective was, to stimulate the economy while preventing capital outflows, having eased pressures as Short-term rates, which couldn’t be lowered much further without undermining the dollar.
The Fed's balance sheet grew the steepest —proir to the years 200 - 2007— in the 4 decades from the Operation Twist interventions in early 1969's see chart 👇🏾
EM Central Bank's in 1990s:
Emerging Markets (1990s crises): Some EM central banks (e.g., Korea post-1997) engaged in quasi-QE, buying government bonds to stabilize financial conditions after banking crises.
Aggregate EM Central Bank Balance sheet expansion, rose steadily in the years 1990-1996, intensifying in 1997 to peak at late 1999 which saw a massive unwind for a year (1999-2000), before gradually scaling up in the six years that would follow.
Bank of Japan:
As far as broader Asia is concerned, Korea was not alone as the Bank of Japan also increased it's balance sheet within that time period, but this was a relatively more gradual approach, up until 2001-2006, as the chat below illustrates.
Thus, balance-sheet tools are “within the long tradition of monetary theory and practice,” as Williams put it, the effectiveness and logic of balance sheet expansion, has historical validation before 2008.
Thus, the volume and pace may have been intense in the years 2008 - 2014, but the action itself is not new.
The chart above indicates however, that the US Federal Reserve Balance Sheet expansion was relatively more excessive than it's peers, and indeed the world, in the six years that preceded the 2007-08 financial crisis, which prompted even more monetary stimulus.
As a result of re evidence above, central bank balance sheet use is hardly a new monetary policy phenomena, and the evidence above supports the New York Fed's President's assertions, for balance sheet use in the years 2008-2014 was hardly unconventional. And neither was it unnecessary. It also aligns deeply with the core of Post-Keynesian economics.
Alignment with Post-Keynesian Economic:
From a theoretical theoretical standpoint, Williams’s argument aligns deeply with the core of Keynesian and Post-Keynesian propositions. Specifically Keynes and Human Minsky.
Keynes: In his “The General Theory” in 1936, Kwnes emphasized the importance of influencing long-term interest rates when the short-term rate hits its lower bound.² His concept of the liquidity trap anticipated that the then conventional rate tools might fail, requiring balance-sheet and expectation-driven interventions to stimulate investment and restore demand.
Hyman Minsky: In his ‘Stabilizing an Unstable Economy’ (1986), Minsky extended Keynes's logic arguing that central banks must act as “dealers in the money market,”⁴ expanding their balance sheets to offset instability born from private financial fragility, embedded in the modern capitalist economy.³
To Minsky, such interventions were intrinsic to capitalism’s cyclical nature, and not deviations, as it stabilizing necessities within a dynamic financial system.⁴
Conclusion:
From the 1930s Treasury purchases to Operation Twist, the Asian Financial Crisis, and Japan’s early QE, the evidence shows that balance-sheet expansion has long been a core monetary instrument.
These historical records were, built on strong theoretical foundations, shows repeated, purposeful use of balance sheet tools by central banks prior to the 2008-2014 expansion.
The Fed’s post-2008 actions, though magnified by crisis scale, remain within that lineage.
The Fed’s so-called “unconventional policies” are actually extensions of long-standing monetary practice. As such, they were not the breach of orthodoxy as they are often portrayed to be, but rather, a reaffirmation of it.
It is perhaps the overwhelming nature and staggering volumes to which central banks extended these powers that can or was being referred to as “unconventional”.
Articles and Papers on Reference:
² Keynes J. M. (1936). The General Theory of Employment, Interest and Money. London, England: MacMillan.
³ Minsky H. P. (1982). Can't it Happen Again? Essays on Instability and Finance. Armonk, N.Y: M. E. Sharpe.
⁴ Minsky H. P. (1986). Stabilizing and Unstable Economy. New Haven C.T. Yale University Press.
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