CAN A central bank make US$2.5trn of cash vanish without anyone much noticing? That is the improbable, even audacious, mission the Federal Reserve has begun, trying to shrink its vast balance-sheet while minimising disturbances to the economy. The process—known as “quantitative tightening” (QT)—got under way in mid-2022. The Fed has already shed nearly US$500bn in assets, a good first step. But recent ripples in the banking system hint at turbulence ahead. Some analysts and investors think these strains will ultimately force the Fed to call off QT well ahead of schedule. Others suspect that the central bank still has time, and tools, on its side.

It may sound like a technical and arcane debate. It is most certainly complex. But it also gets to the heart of modern monetary policy. The Fed, like other central banks, has come to rely on quantitative easing (QE)—purchasing assets, especially government bonds, on a giant scale—to calm financial markets and boost the economy during severe downturns. For QE to work in the future, QT must work now: expanding balance-sheets in bad times is only sustainable if they shrink in good times, otherwise they will ratchet ever higher.

Since the global financial crisis of 2007-9 the Fed has resorted to QE on four occasions, yielding a body of research about how it works. In contrast, the Fed has employed QT just once, from late 2017 to 2019, stopping early after the money market started to buckle. There is thus a lot of uncertainty about its consequences.