The Fed—Quantitative Tightening or Quantitative Easing?

Can the Fed balance its objective of fighting inflation—and help save banks in turmoil? Stephen Dover, Head of Franklin Templeton Institute, opines.

Can central banks simultaneously provide liquidity to banks suffering sharp deposit withdrawals while also slowing money and credit creation by raising interest rates? In essence, can central banks quantitatively tighten and quantitatively ease at the same time?

The actions of the Federal Reserve (Fed) in recent weeks raise these questions. Since the Silicon Valley Bank (SVB) failure, the Fed’s balance sheet has swelled by over US$290 billion1 as the central bank acted as a “lender of last resort” to US banks teetering on the edge of failure. The increase in the Fed’s balance sheet via loans to troubled banks unwound nearly half of its 2022 balance sheet contraction (quantitative tightening).

For investors, the question arises: Can the Fed save banks and achieve its inflation objective at the same time? Must it choose between competing aims?

The answer is yes, the Fed can do both. No trade-off is required. In what follows, we explain why and how—but we add a caveat. Just because the Fed can multitask does not guarantee that it will multitask well. Central banking is always more art than science, and the Fed has a challenging job ahead of it.

Monetary policy versus crisis management

There are several keys to understanding how the Fed can address two challenges simultaneously.