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The Financial Market Effects of Unwinding the Federal Reserve’s Balance Sheet

Andrew Smith () and Victor (Vic) Valcarcel

No RWP 20-23, Research Working Paper from Federal Reserve Bank of Kansas City

Abstract: For the second time in the brief 12-year period between 2008 and 2020, central banks have once again turned to asset purchase programs to combat a global economic downturn. While balance sheet expansions have become familiar, balance sheet normalization has proven more elusive. Nevertheless, an understanding of the consequences of unwinding asset purchases is necessary for well-informed decisions over the deployment of these unconventional policy tools. This paper provides a first analysis of the financial market effects of balance sheet normalization based on the U.S. experience between 2017 and 2019. We find evidence that balance sheet normalization tightens financial conditions. Importantly, we show these effects cannot be merely characterized as quantitative easing in reverse. In particular, we find that balance sheet normalization was associated with larger liquidity effects than were evident during various phases of balance sheet expansion.

Keywords: Monetary Policy; Balance Sheet; Liquidity Effect; Structural VAR; Financial Conditions (search for similar items in EconPapers)
JEL-codes: E3 E4 E5 (search for similar items in EconPapers)
Pages: 34
Date: 2021-01-04
New Economics Papers: this item is included in nep-acc, nep-cba, nep-mac and nep-mon
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DOI: 10.18651/RWP2020-23

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