money-supply, inflation, central-bankPretty much what the title says - if QE can ‘create’ money, can it be destroyed later on and if so, can it be a legitimate measure to manipulate inflation?
Yes.
The Fed can sell the mortgage-backed securities it purchased via QEI and QEII. However, these actions will cause long-term rates to increase. In fact, the Fed is in a predicament because when the Fed attempts this unwind the impact on rates will have the opposite effects which will lead to drops in value of treasury bonds, mortgage-backed securities and lead to a sharp increase in rates.
Here's a nice explanation from John Hussman:
At present, heavy purchases of Treasury debt would be easily accomplished by the Federal Reserve. But once the Fed has quadrupled or quintupled the U.S. monetary base from its level of three years ago, how will it reverse its position? Japan was able to successfully reverse its program of QE several years ago without much impact on yields, but unlike the U.S., it had the luxury of an extremely high savings rate. With nearly 95% of its debt held domestically, Japan had no need to resort to foreign capital. In contrast, over half of the U.S. national debt is held by other countries. Without a deep pool of domestic savings, and with no repurchase agreements in place, the Federal Reserve will eventually have to entice domestic and foreign investors to buy the Treasury securities back, pressuring interest rates higher, and virtually ensuring a capital loss.
It is unlikely that QE will result in a significantly greater use of existing slack capacity and labor in the U.S. economy. But several years from now, as the U.S. economy recovers (no thanks to the Fed, but simply by the emergence of new technologies and markets through innovation), the Fed will have no easy choices. Attempting to sell massive amounts of debt into an expanding economy will risk pressuring interest rates higher and choking off the recovery, while paying interest on reserves to discourage banks from lending them will ultimately require the Fed to pay banks more than the yield on comparable Treasury securities, in order to cover the opportunity cost of keeping the reserves idle.
Yes, a Central Bank can reduce the amount of money in the system, in order to reduce inflation; indeed, for most of the time, that’s pretty much what monetary policy consists of.
But we’re not in normal times at the moment, so Central Banks have been engaged in Quantitative Easing, increasing the amount of money in the system, to stave off deflation. At first they did that by reducing the price of money (Central Bank interest rates) to next-to-zero; and then by directly injecting liquidity into the economy by buying bonds: in the UK, this was almost entirely gilts.
If and when inflation becomes a dominant threat, Central Banks then have a few perfectly legitimate instruments to tackle it:
Additionally, policy makers could mandate that banks should hold higher capital reserves, place restrictions on loans, hold specific proportions of government bonds, and so on.
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