QT and Monetary Policy

Our recent op-ed for Barron’s argued that the Fed and the market were underestimating the tightness of monetary policy. Specifically, they were underweighting the impact of the Fed’s balance-sheet reduction program, known as Quantitative Tightening (QT), on financial conditions. Using Fed-staff methodology, we calculated that the policy rate needed without QT to have an effect on financial conditions equivalent to that produced by the actual policy rate with QT—or what we call the “QT-equivalent policy rate”—was about 40 basis points higher than the current policy rate. As shown in the left-hand graphic above, that gap will balloon to 100 basis points by mid-2025 unless QT is scaled back. Our right-hand graphic illustrates how QT and the QT-equivalent policy rate move in opposite directions through time. If the Fed now wishes to stop tightening policy, then, it will need to end QT, cut rates, or scale back both.