What's Ahead For The Fed's Balance Sheet?

The Fed's asset portfolio is on an uncharted course.

Anyone who has been to Jackson Hole will agree that the view of the stars there is breathtaking. The absence of ambient light creates the perfect setting; it almost seems that the heavens are right on top of you.

At the recently concluded central banking summit in Jackson Hole, there was a lot of talk about stars…of the economic kind. Equilibrium levels of macroeconomic variables are often identified with a star; substantial efforts are made to define those levels and to use them strategically. Of particular interest at this year’s conference was the neutral level of monetary policy, which neither stimulates nor inhibits economic activity.

There are two aspects to this. The first is the natural long-run level of interest rates, or “r-star.” A confident estimate of r-star is critical to determining whether policy is tight or easy. It is also critical to helping markets center their expectations of where interest rates might be heading in the future, based on incoming economic information. Unfortunately, this year’s conference in Wyoming did not yield any additional clarity on where the nebulous R-star stands.

Getting relatively little attention in Jackson Hole was the star denoting the neutral level of central bank balance sheets. Quantitative easing programs have been employed to a substantial extent in the wake of the last two economic crises, and they have had a significant influence. With inflation running higher than desired, quantitative tightening (QT) is underway in a number of countries. Yet we don’t have a sense of where or when this process will end.