The queue to quit QE

Central banks face a daunting task: tapering without the tantrum

Can they stop their bond-buying and avoid upending markets?

THE DEBATE over the effect on markets and the global economy of quantitative easing (QE), the purchase of bonds with newly created money, is almost akin to a culture war. 

To its critics unrestrained QE during the pandemic has covertly financed governments while inflating asset prices and boosting inequality. 

To its fans QE is an essential tool in which economists have justified and growing confidence. 

This high-stakes debate is about to enter a new phase. 

Rich-world central banks’ balance-sheets will have grown by $11.7trn during 2020-21, projects JPMorgan Chase, a bank (see chart). 

By the end of this year their combined size will be $28trn—about three-quarters of the market capitalisation of the S&P 500 today. 

But central bankers are about to turn this mega-tanker of stimulus around.

The justifications for QE have almost dissipated. 

At the start of the pandemic, central banks bought bonds to calm panicky markets amid a flight to safety and a dash for cash. 

Then it became clear that the pandemic would cause an enormous economic slump that would send inflation plummeting; QE was necessary to stimulate the economy. 

Today, however, markets are jubilant and inflation is resurgent.

In America it looks increasingly weird that the Federal Reserve is the biggest buyer of Treasuries, as it was in the first quarter of 2021. 

The economy is powering ahead. 

In June it added a heady 850,000 jobs, according to figures released on July 2nd. 

On Wall Street cash is so abundant that $750bn or more often gets parked overnight at the New York Fed’s reverse-repo facility, mopping up some of the liquidity injected by QE. 

The Fed’s purchases of mortgage-backed securities, amid a red-hot housing market, now look bizarre.

Some central banks have already begun to scale back their purchases. 

The Bank of Canada began curtailing the pace of its bond-buying in April. 

The Reserve Bank of Australia said on July 6th that it would begin tapering its bond-buying in September. 

The Bank of England is approaching its £895bn ($1.2trn) asset-purchase target and looks likely to stop QE once that is reached; Andrew Bailey, its governor, has mused about offloading assets before raising interest rates, contrary to the normal sequencing. 

In May the Reserve Bank of New Zealand said it would not make all of the NZ$100bn ($70bn) asset purchases it had planned to do. 

And the European Central Bank is debating how to wind down its pandemic-related scheme.

By comparison the Fed has been reticent. 

Last month Jerome Powell (pictured), the Fed’s chair, said that the central bank is “talking about talking about” tapering its purchases of assets. 

Most economists expect an announcement on tapering by the end of the year. 

The Fed’s careful approach might reflect its lingering memories of 2013, when it last warned of tapering to come. 

Bonds sold off sharply, the dollar soared and emerging markets suffered capital outflows in what became known as the “taper tantrum”. 

Even Mr Powell’s announcement in June was accompanied by a mini-tantrum of sorts. 

Prompted by higher inflation, officials also indicated that they expected to raise interest rates twice by the end of 2023, sooner than they previously signalled. 

The hawkish turn sent emerging-market currencies tumbling.

QE is swathed in so much mystical uncertainty that working out the impact of unwinding it is no easy feat. 

But a careful examination of central banks’ past experience of asset purchases yields clues for what to expect. 

It also contains lessons for how central banks might be able to extricate themselves from their bond-buying gracefully this time, before the negative side-effects of their enormous balance-sheets start to be felt.

Begin with the effects of changing course. 

Everyone agrees that central banks’ asset purchases reduce long-term bond yields. 

But there is huge uncertainty as to how much they underpin markets today. 

Last year Ben Bernanke, who was the Fed’s chairman at the time of the taper tantrum, suggested that in America in 2014 every $500bn of QE reduced ten-year Treasury yields by 0.2 percentage points. 

On that rule of thumb, adjusted for inflation, the Fed’s total securities holdings of $7.5trn today are suppressing yields by nearly three percentage points (although Mr Bernanke suggested, somewhat arbitrarily, that the overall QE effect might be capped at 1.2 percentage points).

Alternatively, the median estimate of a survey of 24 studies conducted in 2016 by Joseph Gagnon of the Peterson Institute for International Economics suggests that asset purchases worth 10% of GDP reduced ten-year government bond yields by about half a percentage point. 

That suggests that QE today is suppressing long-term rates by just under two percentage points in America, Britain and the euro area—although Mr Gagnon argues that when yields hit their lower bound near zero, as they have in Europe and Japan, QE reaches its limits. 

A bigger bond market may also reduce the size of the effect. 

The Bank of Japan owns government debt worth a staggering 97% of GDP, but Mr Gagnon finds the effects of QE have historically been more muted, perhaps because Japan’s total public debt is more than two-and-a-half times that figure.

These numbers, and the experience of the taper tantrum, make the reversal of QE seem like something that will upend financial markets. 

Sky-high asset prices today reflect the assumption that long-term interest rates will stay low for a long time. 

“We know we need to be very careful in communicating about asset purchases,” Mr Powell acknowledged earlier this year. 

Yet the lessons from the taper tantrum are subtler than they seem—and may even provide some cause for comfort.

When the toys go out of the pram

The taper tantrum of 2013 is associated with Mr Bernanke raising the subject of slowing the Fed’s pace of asset purchases. 

But asset prices fell because investors brought forward the date at which they expected the Fed to raise overnight interest rates, the traditional lever of monetary policy. 

The episode supports the “signalling” theory of QE, which says that central banks’ balance-sheets influence long-term bond yields not directly, as rules-of-thumb suggest, but by acting as a marker for future interest-rate decisions. 

The implication is that you can reverse QE without much fuss if you sever the perceived link between asset purchases and interest-rate decisions.

Some past episodes of tapering seem to observe this rule. 

Indeed, the Fed has already achieved a big tapering of sorts during the covid-19 crisis. 

After the severity of the pandemic first became clear and markets panicked in spring 2020, the central bank hoovered up almost $1.5trn of Treasuries in just two months before dramatically slowing its purchases, which eventually steadied at around $80bn a month. 

But there was no expectation that this slowdown would soon be followed by interest-rate rises and bond yields seemed unaffected. 

In a recent speech Gertjan Vlieghe of the Bank of England, a proponent of the signalling theory, cited this experience, which was mirrored in Britain, as evidence that there is little mechanical link between bond yields and QE.

The Fed also seemed to achieve such a separation the last time it shrank its balance-sheet significantly in 2018 and 2019. 

The passive process—which let assets mature without reinvesting the proceeds, rather than by selling anything—seemed to have no discernible effect on bond yields. 

“The point around signalling and intent is a very salient feature of how QE operates,” says one trader at a big Wall Street bank.

Perhaps, then, central banks can pull off a graceful exit. 

The question is whether rising inflation and booming markets will make them impatient to reverse course more abruptly. 

Some, particularly in Britain, are also wary of three potential undesirable effects of central banks’ balance-sheets that are too large for too long.

The first concern, which has troubled Mr Bailey, is about preserving ammunition. 

A popular view is that QE is highly effective at calming markets during crises when it is deployed quickly and at scale, but has smaller effects in more normal times. 

The danger of prolonging an enormous market presence in good times is that you run out of room to act with force during emergencies. 

Central bankers usually scorn this logic when it is used to argue for higher interest rates, because harming the economy today to rescue it later is to put the cart before the horse. 

But if QE works best in a crisis then withdrawing it in normal times should not be so painful. 

Not doing so might mean a gradual ratcheting up, during each crisis, of the share of government debt that central banks own.

The second worry is the unseemly tangle of monetary and fiscal policy that QE creates. 

During the pandemic central banks have routinely faced the accusation that QE is meant to fund governments; in January a survey by the Financial Times of the 18 biggest investors in Britain’s gilt market found that the “overwhelming majority” thought the purpose of the Bank of England’s bond-buying was to finance the government’s emergency spending, rather than to support the economy.

But although lower bond yields help the government’s finances, QE does not extinguish the government’s financing costs. 

It just shifts them to central banks, whose profits and losses end up back with the taxpayer. 

The central-bank reserves created to buy bonds carry a floating rate of interest, making them analogous to short-term government borrowing. 

Over the past decade, issuing short-term liabilities to buy long-term debt has been a profitable strategy. 

Between 2011 and 2020 the Fed sent over $800bn in profits to the Treasury; the Bank of England’s asset-purchase facility transferred £109bn to British taxpayers.

If interest rates rose, however, central banks’ enormous balance-sheets could become lossmaking. 

That could have sizeable consequences for the public finances: in November 2020 Britain’s Office for Budget Responsibility estimated that the country’s debt-service costs had become twice as sensitive to short-term interest rates as they were at the start of the year, as a result of the combination of QE and increased debt. 

Every one-percentage-point increase in short-term interest rates will raise the cost of servicing debt by 0.5% of GDP by 2025-26. 

In large rich countries 15–45% of public debt is “in effect overnight”, calculates the Bank for International Settlements. Some economists also worry that central banks could see their independence compromised were they to require cash injections from governments.

The final factor is appearances. 

The prominence of central banks’ holdings of public debt has helped create a widespread impression that governments can spend with abandon. 

It has had weird effects, such as sending measures of the broad money supply through the roof, contributing to fears of inflation. 

Politicians eye central banks ever more greedily, wanting to use QE to further goals such as reducing inequality and fighting climate change. 

During times of economic crisis central bankers have to lead from the front. 

As normality returns, so should their desire to seek a lower profile.

Summer Travel Is Back. Earth Can’t Handle It.

By Farhad Manjoo

Credit...Brendan Smialowski/Agence France-Presse — Getty Images

To cruise or not to cruise? 

To safari or stay put? 

To fly — perchance to hang glide or kite surf into some un-Instagrammed country. 

So goes the great moral dilemma now lurking in the travel and tourism industry, perhaps the beating heart of global consumerist extravagance. 

Now that our year-plus fast is close to over, shall we commence gorging once more?

In 2019, according to an industry trade group, the world spent about $9 trillion dollars — nearly a tenth of global G.D.P. — on tourism. 

It was the 10th consecutive year of growth in travel, and expansion looked endless.

Heedless success was the industry’s main problem. 

If you traveled anywhere during the summer or two before the Covid-19 pandemic, you weren’t alone; across the world, officials wrestled with the civic and environmental costs of overtourism. 

Each summer, armadas of cruise ships would spew stinking streams of people and pollution into the world’s beloved port cities. 

At Disneyland, wait times for the hottest rides stretched to two hours — which was at least better than on Mount Everest, where overcrowding on some of the mountain’s most dangerous spots created deadly queues and effectively turned the summit into the world’s highest garbage dump. 

A Times art critic called on the Louvre to take down the Mona Lisa, who had grown so thickly thronged with Instagramming bucket-listers that she was now, he wrote, “a black hole of anti-art who has turned the museum inside out.”

Exploration is an ancient and sometimes even noble human endeavor, and as the virus abates, those of us fortunate enough to be able to entertain such possibilities are yearning to make up for lost vacationing. 

The global economy may depend on the rapid rebirth of tourism. 

Travel was, of course, one of the industries hit hardest by the pandemic. 

Tens of millions of jobs and trillions of dollars in economic activity are riding on its return to normality.

But that would be a mistake. 

Tourism should not return to anything like its old, profligate normal. 

The pandemic has presented the world with an opportunity to reset how we tour this planet, and we should reach for it.

Some places are doing so. 

In Amsterdam — a city of fewer than a million residents that was mobbed by more than 21 million visitors in 2019 — leaders are considering new regulations for the city’s famous red-light district and cannabis shops, which locals say attract too many rowdy crowds. 

Calanques National Park, in southern France, has started a demarketing campaign to dissuade online influencers from talking up the place. 

But I fear that many countries will find it difficult to keep tourism at bay. 

Already, in the name of quick economic rehabilitation, politicians and companies are pushing for a hasty return to the ways of the past, and then some. 

Some European countries have reopened to tourists from the United States, and airlines are clamoring for the Biden administration to reciprocate by opening America back up to the world.

Let us not be so hasty. 

In planning for the future of travel, all of us — travelers, people in the travel industry and the governments that regulate the business — would be wise to follow the careful traveler’s most reliable maxim: Go slow.

We should exercise caution not just because the virus remains very much still out there; it’s also because, in the years before the virus, tourism grew unsustainably and to excess, driven less by sincere wanderlust than preening digital self-regard. 

Technology hadn’t just made travel very cheap but had also cheapened it. 

Glorious Instagram sunsets blinded us to the enormous planetary costs of travel. 

The United Nations World Tourism Organization estimated that tourism accounted for about 5 percent of the world’s human-produced carbon emissions in 2016. 

Another study found that from 2009 to 2013, tourism was responsible for 8 percent of global greenhouse gas emissions and that the industry is growing fast enough to outstrip its meager efforts to decarbonize.

It is in the travel industry’s own long-term interest to curb these costs; a world suffering from serial climate disasters is not a very pleasant place to tour. 

Yet for years the tourist sector has been largely allowed a free pass for its environmental devastation.

I have written already about how the pandemic should prompt a rethinking of air travel. 

This is most true in the business world. 

Sure, there’s something magical about meeting face to face, but in an age of pretty good videoconferencing, there isn’t magic enough to justify the extreme environmental costs of routine flight. 

But flying is so carbon intensive — your share of the emissions from a single round-trip trans-Atlantic flight are almost enough to wipe out the gains you might get from living car-free for a year — that it’s worth considering limiting leisure plane trips, too. 

Some people can afford to travel to Europe every year, maybe even several times a year. 

I’m not one for flight shaming, but that level of indulgence ought to earn some measure of social opprobrium.

Cruises present an even better target for radical reform, if not outright prohibition. 

The early days of the pandemic highlighted the cruise industry’s vulnerability to contagion, but getting disease under control should be just the first step for this most polluting of conveyances. 

According to one study, a midsize cruise ship can emit as much particulate as one million cars. 

One cruise company alone, Carnival, was responsible for 10 times as much sulfur oxide as that emitted by the roughly 260 million passenger cars on European roads in 2017, a 2019 analysis found.

This week I called Rick Steves, the travel writer and tour operator, to ask about the future of travel on a warming planet. 

For most of his life, he visited Europe at least once a year. 

Last summer was the first time in decades that he didn’t go, and he’s staying home again this year.

Steves told me that time at home has given him a new perspective on travel — both its liberating psychic possibilities and its heavy costs.

“I’ve gained an appreciation for the fragility of the environment and the importance of people and nations to not be afraid of each other but work together,” he told me. 

Like the battle against climate change, fighting the pandemic required coordination among politicians, scientists, regulators and businesses around the world. 

That kind of coordination is fostered by the trust and empathy gained by global travel, Steves said. 

The rub is that travel itself is worsening the crisis — and because the industry’s impact has been so loosely policed by the world’s governments, it has little incentive to make difficult changes to its operations.

To mitigate the environmental cost of his European travel business, Steves has turned to carbon offsets. 

For each of the 30,000 or so passengers the company takes to Europe in an ordinary year, the company contributes $30 for environmental initiatives meant to curb the costs of climate change. 

Many airlines now offer passengers the chance to pay for emissions offsets.

But because all these programs are voluntary, their impact seems limited. 

And at the moment, there is little political incentive to impose new regulations on struggling travel companies.

In May the Senate unanimously passed a bill allowing cruise ships to return to Alaska. 

The House quickly passed it, too, and when it got to his desk, President Biden signed it. 

The law, he tweeted, would “support Alaskans by allowing large cruise ships to return to the state this summer.”

The law made no mention of the environment. 

Neither did the president. 

The Global Tax Devil Is in the Details

Under existing tax rules, multinational firms can escape paying their fair share of taxes by booking their income in low-tax jurisdictions, or by moving some parts of their business to these jurisdictions. Will proposed reforms deliver on their promise to boost government revenues, especially in developing countries?

Joseph E. Stiglitz

NEW YORK – It appears that the international community is moving toward what many are calling a historic agreement to set a global minimum tax rate on multinational corporations (MNCs). 

It’s about time – but it may not be enough.

Under the existing rules, firms can escape paying their fair share of taxes by booking their income in low-tax jurisdictions. 

In some cases, if the law doesn’t permit them to pretend that enough of their income originates in some tax haven, they have moved some parts of their business to these jurisdictions.

Apple became the poster child of tax avoidance by booking profits made on its European operations to Ireland, and then using another loophole to avoid most of Ireland’s notorious 12.5% tax rate. 

But Apple was hardly alone in turning the ingenuity behind products we love toward avoidance of taxes on the profits earned from selling them to us. 

They rightly claimed that they were paying every dollar due; they were simply taking full advantage of what the system offered them.

From this perspective, an agreement to establish a global minimum tax of at least 15% is a major step forward. 

But the devil is in the details. 

The current average official rate is considerably higher. 

It is thus possible, even likely, that the global minimum will become the maximum rate. 

An initiative that began as an attempt to force multinationals to contribute their fair share of taxes could yield very limited additional revenue, much lower than the $240 billion underpaid annually. 

And some estimates suggest that developing countries and emerging markets would also see a small fraction of this revenue.

Preventing this outcome depends not just on avoiding a downward global convergence, but also on ensuring a broad and comprehensive definition of corporate profits, such as one that limits deduction for expenses relating to capital expenditures plus interest plus pre-entry losses plus... It would probably be best to agree on standard accounting so that new tax-avoidance techniques do not replace the old ones.

Particularly problematic in the proposals advanced by the OECD is Pillar One, intended to address taxing rights, and applying only to the very largest global firms. 

The old system of transfer pricing was clearly not up to the challenges of twenty-first-century globalization; multinationals had learned how to manipulate the system to record profits in low-tax jurisdictions. 

That’s why the United States has adopted an approach whereby profits are allocated among the states by a formula that accounts for sales, employment, and capital.

Developing and developed countries may be affected differently depending on which formula is used: an emphasis on sales will hurt developing countries producing manufactured goods, but may help address some of the inequities associated with the digital giants. 

And for Big Tech firms, the value of sales must reflect the value of the data that they garner, which is crucial to their business model. 

The same formula may not work in all industries.

Still, the advances made in current proposals have to be recognized, including moving away from the “physical presence” test for imposing taxes – something that makes no sense in the digital age.

Some view Pillar One as a back-up to the minimum tax, and are thus not concerned about the absence of economic principles guiding its construction. 

Only a small fraction of profits in excess of a certain threshold are to be allocated – implying that the total share of profits to be allocated is indeed small. 

But with firms permitted to deduct all production inputs, including capital, the corporate income tax is really a tax on rents or pure profits, and all of those pure profits should be up for allocation. 

Thus, the demand by some developing countries that a larger share of corporate profits be subject to reallocation is more than reasonable.

There are other troublesome aspects of the proposals, as best as can be found out (there has been less transparency, less public discussion of the details than one would have expected). 

One concerns dispute resolution, which clearly can’t be conducted using the kinds of arbitration now prevalent in investment agreements; nor should it be left to a corporation’s “home” country (especially with footloose corporations looking for favorable homes). 

The right answer is a global tax court, with the transparency, standards, and procedures expected of a twenty-first-century judicial process.

Another of the proposed reforms’ problematic features concerns the prohibition of “unilateral measures,” seemingly intended to curb the spread of digital taxes. 

But the proposed threshold of $20 billion leaves many big MNCs outside the scope of Pillar One, and who knows what loopholes smart tax lawyers will find? 

Given the risks to a country’s tax base – and with international agreements so difficult to conclude and MNCs so powerful – policymakers may need to resort to unilateral measures.

It makes no sense for countries to give up any of their taxing rights for the limited and arbitrary Pillar One. 

The commitments asked are incommensurate with the benefits given.

The leaders of the G20 will do well to agree on a global minimum tax of at least 15%. 

Regardless of the final rate that sets the floor for the 139 countries currently negotiating this reform, it would be better if at least a few countries introduced a higher rate, unilaterally or as a group. 

The US, for example, is planning on a 21% rate.

It is crucial to address the host of detailed issues required for a global tax agreement, and it is especially important to engage with developing countries and emerging markets, whose voice has not always been heard as clearly as it should be.

Above all, it will be essential to revisit the issue in five years, not seven, as currently proposed. 

If tax revenues do not increase, as promised, and if the developing and emerging markets fail to garner a greater share of those revenues, the minimum tax will have to be raised and the formulae for allocating “tax rights” readjusted.

Joseph E. Stiglitz, a Nobel laureate in economics and University Professor at Columbia University, is a former chief economist of the World Bank (1997-2000) and chair of the US President’s Council of Economic Advisers, was lead author of the 1995 IPCC Climate Assessment, and co-chaired the international High-Level Commission on Carbon Prices.