To assess the overall stance of monetary policy, we need to take into consideration the effects of both the interest rate policy and the balance sheet policy. A natural question then arises: what is the equivalence between interest rate hikes and QT?

This is a challenging question as the experience with QT is limited. historically, there was only one round of QT.

According to a June study published by the Fed, a $2.5tn drawdown in the balance sheet over the next few years would be roughly in line with just over a half-point increase in the benchmark US policy rate — a range in keeping with Fed vice-chair Lael Brainard’s assessment that the central bank’s plans amount to “two or three additional rate hikes”. In other words, a year’s worth of QT, or about $1 trillion, is roughly equivalent to a single 25bp rate hike.

Even though the Fed may claim it would be roughly just over 50bps, the actual estimate of the equivalence between interest rate hikes and QT depends on several factors such final size of the Fed’s balance sheet, the interaction with the demand for liquidity in the financial system and the financial markets condition. Another factor that influences how QT affects interest rates is the maturity structure of Treasury debt.

A recent paper, from researchers at the Atlanta and Kansas City Fed regional banks, claims that in the baseline scenario of a $2.2 trillion passive roll-off over three years, it is equivalent to an increase of 29 basis points in the current federal funds rate during a period of low financial market volatility. The amount of equivalent rate hikes increases to 74 basis points during a volatile market period. A hefty blow that could tighten monetary policy more than the Fed expects.

The episode between 2017 and 2019 showed: With rising asset runoff volumes, the tension in money markets was increasing.

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