60 seconds explaining quantitative tightening

Janet Yellen, chair of the Federal Reserve (Fed), has announced the Fed is going to introduce a new policy called quantitative tightening (QT).

This is very different from quantitative easing (QE).

QE was when the Fed created brand new money (around $3.5 trillion) to go and buy financial assets, principally government bonds, to suppress interest rates across the entire economy.

By reducing those interest rates, the thinking is that it should induce us to go and borrow more money because it’s much, much cheaper to borrow. And, if one man spends money because he’s borrowed some, then it’s another man’s income. That’s really good for the economy.

In reality though, we all had far too much debt following the financial crisis, so that borrowing never really happened irrespective of the level of interest rates.

$3.5 trillion is a lot of money, to put it mildly. To think about it this way; if you were to spend $20 a second, every second of every day, every day of every month and so on, how long would it take you to spend $3.5tn at that rate?

The answer is around 5,500 years. So, for you to be finishing around now, you’d have had to have started around the year 3500 B.C. Quite some time.

We’ve taken that QE, and finished it. Janet Yellen has now said they're going to do QT, so instead of putting money into the economy, she’s taking money out. This is because actually, everything looks fine; unemployment is low and growth is pretty good.

She’s said she’s going to do it in such a boring manner, it’s going to be like "watching paint dry".

It will be around $10 billion a month for the next few months, then $20 billion, then 30, then 40, then 50. These are really big numbers.

If you agree with us that QE pushed asset prices up, maybe we’re going into a slightly different environment now.