I just read a post on the subject of reversing quantitative easing. Just a quick few points:
For a given velocity of asset focussed money supply and a given preferred allocation of money within the “asset portfolio”, the withdrawal of liquidity will impact the demand for assets via a) increased supply of certain assets, b) the reduced amount of money and hence readjustment of preferred percentage money allocation and c) via changes in asset preferences, in particular preferences for assets that may have increased in supply as QE was taking place.
With QE, we have the introduction of higher levels of portfolio focussed cash with a reduction in relative supply of higher quality assets and this would cause problems if this also skews the universe of demand and supply for higher risk/less liquid assets: that is the universe pushes outwards.
As QE is reversed and money is withdrawn and lower risk/more liquid assets are injected into the asset portfolio, demand for higher risk/less liquid assets may drop as these assets are displaced within the asset portfolio: that is the asset universe contracts.
The issue here is that we risk a secondary asset impact over and above the expected price adjustment of all assets as portfolio liquidity is withdrawn. Unconventional monetary policy is likely to have altered the asset profile of the asset portfolio and this adjusted profile is likely to be hit most at its weaker newly developed extremities .
The risk is that certain asset classes get crushed in the rush for the exits. The question is how much does the market for these asset classes at the outer edge of the universe get impacted and to what extent will this likewise impact consumption and future consumption expectations? If you cannot sell an asset you bought at a certain price with an expectation over a future value with any degree of certainty, then we have a discounted present value demand shock. If QE is substantial and the potential reverse substantial too, this shock can be quite large.
QE may not just have impacted pricing but also market structure, liquidity, and introduced larger amounts of higher risk/less liquid assets into core portfolio destinations than would have occurred without it.
This is not a complete analysis by any means but we have changed the nature and structure of asset markets and therefore the relationship with asset markets and consumption functions.
I discussed some of these issues in another related post: