Can the ECB escape its own trap?
The policy dilemma facing central banks as they try to shrink their bloated balance sheets
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IT IS now widely acknowledged that most central banks underestimated the threat of inflation when they persisted with extremely low interest rates and massive asset purchases throughout 2021 and into 2022.
Fortunately, when they did finally change course, they showed remarkable determination, with the European Central Bank (ECB) raising interest rates by 375 basis points (bps) in less than a year (and the US Federal Reserve raising its policy rate by 500 bps).
But reversing the policy of massive bond purchases is proving more difficult. A decade of quantitative easing (QE) has significantly expanded the ECB’s balance sheet and created a liquidity glut, leaving policymakers in a trap from which they are struggling to escape.
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