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Rethinking the Monetization Taboo

Now that the pace of the US Federal Reserve’s “tapering” of its asset-purchase program has been debated to death, attention will soon turn to prospects for interest-rate increases. But a far larger question looms: How will central banks return balance sheets swollen by unconventional monetary policy to “normal” levels?

LONDON – Now that the pace of the US Federal Reserve’s “tapering” of its asset-purchase program has been debated to death, attention will increasingly turn to prospects for interest-rate increases. But another question looms: How will central banks achieve a final “exit” from unconventional monetary policy and return balance sheets swollen by unconventional monetary policy to “normal” levels?

To many, a larger issue needs to be addressed. The Fed’s tapering merely slows the growth of its balance sheet. The authorities would still have to sell $3 trillion of bonds to return to the pre-crisis status quo.

The rarely admitted truth, however, is that there is no need for central banks’ balance sheets to shrink. They could stay permanently larger; and, for some countries, permanently bigger central-bank balance sheets will help reduce public-debt burdens.

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