This Great Graphic comes from Also Sprach Analyst blog. It depicts the balance sheets of the Federal Reserve, Bank of England, European Central Bank and the Bank of Japan.
What will surprise many is that the Fed's balance sheet has shrunk for nearly a year and, as a percentage of GDP, its balance sheet is not as large as the other major countries.
With the announcement of QE3+, the Federal Reserve's balance sheet will expand. Despite the fall in the unemployment rate in September to below 8%, we continue to believe it is most probable that the FOMC replaces the long-end purchases being conducted under Operation Twist, which will be completed by year-end, with new outright purchases. We are assuming the Fed's balance sheet will increase by roughly $1 trillion by the end of next 2013.
If every things else was held constant, the this would put the size of the Fed's balance sheet as a percentage of GDP above the Bank of England, but still below the ECB and BOJ. However, it is also reasonable to expect the BOE to extend its gilt purchases, when the current program is completed next month. The BOJ expanded its asset purchases program and is likely to do so again next year, if not before. The ECB announced an sovereign bond purchase program (Outright Market Transactions), but is waiting for a formal request to trigger it.
In any event, it is reasonable to expect the balance sheets of these major central banks to expand in the months ahead. We make three important points.
First, just like the expansion of the government's balance sheet became a permanent part of the political economy after the Great Depression, so too out of this crisis, we suspect the central banks' balance sheet will become a permanent or semi-permanent feature of the political economy post-Great Recession.
Second, there are many forces that impact exchange rates. The Quantity of Money Theory (e.g. MV=PT) has been debated for generations (both Keynes and von Mises offered critiques). The relative quantities of money may at times be helpful in forecasting currency movement, but there are other drivers as well. Moreover, the drivers can and do change over time.
Third, leaving aside economic first principles, looking at the central banks that have expanded their balance sheets, it is difficult to claim that QE leads to a depreciating currency or inflation, as the BOJ's experience illustrates.