How high is the cost of US QE? Former Fed leader: Total bill may exceed $500 billion!

This week, the Federal Reserve may announce plans to slow the pace of balance sheet reduction. Former New York Fed President Bill Dudley wrote on Tuesday that while quantitative easing by the Federal Reserve has been effective, the cost is too high, with total costs potentially exceeding $500 billion.

Dudley said that while quantitative easing stabilized the market during the COVID-19 pandemic and provided economic stimulus when further interest rate cuts were not possible, the costs of the Fed's asset purchase program must also be considered, which mainly include three aspects.

First, lowering mortgage rates excessively stimulated the real estate market, leading to a surge in demand, driving up housing prices and overall inflation.

Second, this also contributed to the regional bank failures last year. The Fed's bond purchases injected a large amount of money into the market, which turned into part of the savings, causing banks to manage a surge in funds. While the behavior of regional banks like Silicon Valley Bank investing deposits in long-term fixed-rate securities was foolish, the Fed, which initially created the flood of liquidity, also bears responsibility.

Third, from the perspective of the US dollar, it is very expensive. Since the Fed raised short-term rates to over 5%, interest payments on its liabilities (including bank reserves) far exceed its income from holding securities. The Fed lost over $100 billion last year, with cumulative losses potentially reaching $250 billion.

But the real costs are much higher: without quantitative easing, given that its liabilities are mainly interest-free currency, the Fed should have made significant profits. Ultimately, the difference between what it actually earned and what it could have earned may exceed $500 billion.

In Dudley's summary, pushing the costs of quantitative easing to such high levels is mainly due to three mistakes by the Fed. First, the Fed purchased assets for longer than necessary. After the appearance of the COVID-19 vaccine at the end of 2020, officials should have realized that with the economic reopening, growth would rebound, and the massive fiscal stimulus from the federal government would make further unconventional monetary stimulus unnecessary.

Second, the Fed decided to continue asset purchases until substantial progress was made on employment and inflation targets, and to gradually reduce purchases slowly rather than abruptly. Therefore, despite strong growth and high inflation, it continued purchases in the first quarter of 2022.

Third, the Fed committed to not raising rates until reaching inflation and employment targets. This led to a too slow response to an overheating economy and higher inflation, requiring more aggressive action. If the Fed had tightened monetary policy earlier, the peak of short-term rates could have been significantly lower, reducing losses.

Dudley believes that the Fed's excessive expansion of its balance sheet directly increased the costs of quantitative easing. The final $1 trillion in asset purchases completed between June 2021 and March 2022 could ultimately result in the Fed (and US taxpayers) losing $100 billion, with minimal returns. He calls on Fed officials to evaluate the quantitative easing program in next year's monetary policy framework review, learn from past mistakes, and control costs