By Howard Schneider

WASHINGTON (Reuters) – The Federal Reserve will start to shutter its pandemic-era bond-buying program later this year, leaving the U.S. central bank with a balance sheet of more than $8.5 trillion before the purchases end in mid-2022 and a likely debate coming about what to do different next time.

It may not be obvious. The Fed has roughly doubled the size of its securities portfolio since the outbreak of the pandemic early 2020. They also used ongoing purchases to show that they would fight the crisis as long as possible. Now, it is planning its end-of-life without any market “tantrums” and will begin closing down its bond-buying program.

After a two day policy meeting ended, Fed Chair Jerome Powell spoke to journalists on Wednesday. He said that the central bank will soon begin paring $120 billion of monthly asset purchases and stop them in the middle next year.

“It served its purpose,” said Tom Garretson, senior portfolio strategist at RBC Wealth Management.

Garretson, along with others, noted that, beyond its initial effect on the financial markets, there is no way to know if Fed bond-buying or “quantitative ease” (as it’s commonly known) would have been sufficient to compensate last year’s severe, but short, recession that occurred without massive spending by Congress.

What’s the take-away? The takeaway? Both the Fed’s monetary policy and elected officials’ fiscal programs will have to work together during future recessions.

David Wilcox is a former chief of the Fed’s Research Division and now senior fellow at The Peterson Institute for International Economics. “The main lesson…is that the tools provided by the Federal Reserve or other central banks are significantly inadequate for dealing with material weakness in economic activity.

UNCONVENTIONAL NO LONGER

Both the Fed’s crisis response and some of the fiscal aid out of Washington are now set to shrink, which could act as a drag on an economy still emerging from the pandemic, with growth expected to slow in 2022 after a healthy rebound this year.

However, these programs had unexpectedly good outcomes. These included an increase of household incomes and wealth as well as a decrease in poverty in spite of the recession.

The Fed’s once unconventional purchases of U.S. Treasury Bonds and Mortgage-backed Securities as part of its monetary policy was consolidated by the pandemic. This is the best way to help the economy after the benchmark overnight interest rate (or federal funds rate) has been reduced to zero.

The Fed also temporarily expanded the range of securities it could purchase to include corporate and municipal bonds.

Roosevelt Institute economist Mike Konczal stated that this should become a part of Fed policy permanently at a Thursday congressional hearing.

Konczal claimed that these efforts proved to be more effective than most people believe. By reducing borrowing costs, local governments and businesses were able to borrow less. He also said they are an evolution of “unconventional monetary policy” and will likely continue with the Fed.

Others central banks have expanded the range of assets that they can buy beyond government securities.

Some elected officials were not happy with the scale or length of Fed purchases in the aftermath of the pandemic. Others felt that the program had been providing no benefit over the past few months.

(GRAPHIC: The Fed’s climbing balance sheet – https://graphics.reuters.com/USA-FED/TAPER/egpbkyjnrvq/chart.png)

That may argue for more flexibility during the next crisis around how and when to end the asset purchases.

The performance of the labor market was tightly tied to Fed’s QE-driven by pandemics. William English, former chief of the Fed’s Monetary Affairs Division, stated that with the unemployment rate rising faster than the overall economy, the Fed had to provide an exit hatch.

ANNOUNCEMENT EFFECTS

QE entered the lexicon of U.S. monetary policy in 2009 as part of then-Fed Chair Ben Bernanke’s response to the 2007-2009 financial crisis and recession.

Contrary to the European Central Bank the Fed hasn’t wanted to use negative interest rates in order to stimulate the economy. Therefore, once the Federal Funds Rate is at its “zero lower bound”, the Fed uses bond purchases to lower credit costs. The Fed encourages home and auto purchases, which can increase asset prices as well and lead to greater wealth-effect spending.

It is still a matter of dispute whether it works and what the risks are.

Since 2009, nearly 80 papers have been published by Fed policymakers and staff analyzing the risks and benefits of QE. It helps in crisis situations when the announcements of support by central banks can boost confidence, and then over time anchor interest rates.

One indicator of that impact, what’s known as the shadow federal funds rate https://www.atlantafed.org/cqer/research/wu-xia-shadow-federal-funds-rate, is currently estimated at -1.8%, in effect where the Fed’s target rate would need to be to produce the current levels of bond yields.

(GRAPHIC: The Fed’s “shadow rate” and QE – https://graphics.reuters.com/USA-FED/QE/klvykgnxxvg/chart.png)

One of the reasons it may be hard for the Fed to deviate much from the way it did QE during the pandemic is precisely because it is the early promise of open-ended support that seems to be a chief benefit.

Next time, the details could change. The mix of monthly assets purchases is a matter of dispute among policymakers. It was split between $40 billion in mortgage-backed assets and $80 billion in Treasury securities. This comes at a moment when home prices have soared.

If the pandemic has shown anything it is that size matters. It’s also that you can plan for the worst but be amazed at the positives. In March 2020 the pandemic appeared to be a lasting, Great Depression-level event. The U.S. central banks cut the federal funds rates to almost zero in March 2020 and committed to buying assets. Its securities holdings rose from $3.8 billion to about $5.9 Trillion by May.

Roberto Perli, Cornerstone Macro economist said that “we can all complain about QE being impractical and not knowing how it works or how much it does.”

But what about the alternatives? Perli agreed. You will most likely have to repeat the process in the next recession, but with a reasonable size and the same composition.