The fiscal cost of quantitative easing

IN accumulating massive bond holdings over the course of a decade of quantitative easing (QE), central banks were effectively betting that interest rates would stay low indefinitely. They have lost that wager.

Economists agree: Central banks’ bond-buying programmes constitute a quasi-fiscal policy, as monetary authorities finance their purchases of long-term government bonds by issuing short-term reserves to commercial banks. Until recently, this seemed to be good business. While the bonds technically yielded little, the cost of financing was so low (-0.5 per cent in the eurozone, for example) that central banks reaped profits anyway.

But with inflation skyrocketing, reaching double-digit rates in many countries, central banks have had little choice but to increase their policy rates rapidly. This has raised the costs of financing, with short-term rates now exceeding long-term bond yields. As a result, the fiscal risks of bond-buying programmes are being realised, with central banks facing losses on their holdings.