Quantitative Easing (QE)
Contributors
Lillian Han is an undergraduate junior at Columbia University majoring in Economics-Mathematics. She is interested in monetary policy, game theory, and labor economics, and works as a research assistant on projects related to child health and welfare policy in the US. She enjoys teaching and works as a teaching assistant for Columbia’s math department and taught a course on Game Theory and Economics at Johns Hopkins’ Center for Talented Youth.
Key things to know
Quantitative easing (QE) is an unconventional monetary policy tool first introduced by the Bank of Japan in 2001 and later adopted by other central banks. It is used during economic recessions when conventional short-term interest rate policies are insufficient, and additional monetary stimulus is needed. It consists of large-scale asset purchases by central banks, usually of Treasury securities and mortgage-backed securities.
Conventional monetary policy involves the use of targets for short-term nominal interest rates. Usually, the central bank’s target interest rate should go up if inflation exceeds its target (2% for the US), and the target should go down if aggregate output falls below the economy’s potential.
The issue with conventional monetary policy is that there is a limit to how low these interest rates can go, also known as the effective lower bound (this is zero in the US, but is negative for some countries). The Fed was faced with this situation during the 2008 Great Recession and in 2020 because of COVID-19 and used QE in response to these recessions.
QE provides additional stimulus by providing liquidity to frozen credit markets and lower interest rates of various maturities to stimulate aggregate demand. By stabilizing economies and ensuring access to capital, QE has the potential to create conditions for broader economic participation during economic downturns and enhance societal resilience.
Because QE is a relatively new unconventional monetary policy, economic theory is lacking and empirical evidence is open to interpretation because of the small amount of data.
Case studies
2008 Great Recession
Amid the financial crisis in fall of 2007, the Fed responded in the conventional way by lowering short-term interest rate targets. However, by the end of 2008, the federal funds target rate had reached the zero lower bound, yet the economy and financial system were still in trouble. Policy makers and economists were concerned that the US economy could fall into a deflation spiral, further depressing the economy. Thus, over the next several years, the Fed conducted three rounds of large-scale asset purchases, increasing its balance sheets by more than four times to about $4.5 trillion in 2015.
November 2008, QE 1: the Fed bought $1.25 trillion in mortgage-backed securities (MBS), $175 billion in federal agency debt, and $300 billion in US Treasury securities
August 2010, QE 2: the Fed bought $600 billion in long-term Treasury securities
September 2012 QE3: the Fed made monthly purchases of $40 billion in agency MBS and $45 billion in US Treasury securities. In December 2013, the Fed announced tapering of purchases and the purchases concluded in October 2014.
The short-term effects of QE can be seen in mortgage refinancing. When the Fed bought MBS during QE1, there was an immediate boom in the refinancing of existing mortgages. When households refinanced their existing mortgages at a lower interest rate, their net worth increased because their debt burden decreased. This increase in net worth thus allowed households to increase their consumption, which helped stimulate aggregate demand. Short-term effects of QE were also observed through bank lending. Banks that owned more MBS prior to QE experienced faster growth in loans to firms and households than banks that had little MBS holdings. By purchasing MBS, the Fed made the banks’ assets more liquid, which helped stimulate additional credit provision by banks.
In the long term, most studies have concluded that QE had a positive association with GDP growth and inflation, although the size and persistence of the effects are shown to vary. Some studies have shown that three QE events were associated with an increase in US GDP by about two percentage points, although others find its effectiveness inconclusive. Other effects included lower long-term interest rates, potential asset price inflation, a possible widening of wealth inequality, and a potential for reduced bank lending in the long run. While QE is generally considered to have helped stabilize the financial system during the crisis, the extent to which it directly stimulated economic growth has shown mixed results.
COVID-19 Pandemic
The COVID-19 pandemic which began in February of 2020 led to business closures, event cancellations, and work-from-home policies that signalled a deep economic downturn in US and global economies. The uncertainty around the virus and the economy led to a “dash for cash,” or a desire to hold deposits and liquid assets, which disrupted financial markets. The US unemployment rate rose to 14.7% in April 2020, highest since the Great Depression, and US GDP fell by 32% in the second quarter of 2020. The US government responded to the crisis with fiscal policies to provide stimulus to the economy and relief to those affected, while the Fed engaged in monetary policies. Among the Fed’s policies, which included interest rate cuts, loans and asset purchases, and regulation changes, was QE. Having cut the fed funds rate to a range of 0 to .25%, the Fed engaged in QE to keep the credit flowing to limit economic damage. The Fed financed these activities by expanding its balance sheet, which surpassed its previous all-time high by March 2020 and exceeded $7 trillion by May 2020.
March 2020: the Fed announced it would buy at least $500 billion in Treasury securities and $200 billion in MBS.
June 2020: the Fed set its rate of purchases to at least $80 billion a month in Treasuries and $40 billion in MBS
November 2021: judging that the economy has made substantial progress in employment and price stability, the Fed begin tapering its asset purchases
One of the effects of QE was lowering borrowing costs. Because QE drove down yields on US Treasuries and other fixed-income securities, it reduced borrowing costs for business, households, and the government. This encouraged mortgage refinancing, home purchases, corporate borrowing, and indirected supported the swift and expansive implementation of fiscal policies (stimulus checks, unemployment benefits, aid to businesses, etc) by keeping government borrowing costs low. By reducing yields on safe assets like Treasuries, QE also pushed investors towards riskier assets like stocks, helping the US stock market to recover and contributing toward an overall stabilization of financial markets. This stabilization helped support job retention and creation, and the US saw rapid recovery in labor markets in 2021 and 2022.
Compared to its implementation during the Great Recession, QE was less effective during COVID-19 because of the higher level of preexisting bank reserves in 2020. This abundance in reserves limited the capacity of QE to enhance liquidity meaningfully. Additionally, the unique nature of the COVID-19 crisis, marked by widespread shutdowns and supply chain disruptions, meant that monetary stimulus had less direct impact on stimulating demand or production. Instead, direct lending programs (which bypassed traditional monetary channels by delivering funds directly to those most in need) seemed to have played a more pivotal role in mitigation financial challenges,
Although initially QE helped stave off deflationary pressures, as the economy strengthened but supply chains still remained slow to follow, the massive liquidity injection contributed to a significant rise in inflation. This directly impacted low to moderate-income families, whose wages were not keeping up with the rising prices. Additionally, rising stock and real estate prices increased wealth for those with significant investments, while lower income households who had fewer assets saw limited direct benefits from QE. Thus, some economists argue that while QE supported overall economic recovery, its benefits may not have been evenly distributed.
Comparisons of QE Across Central Banks During the Pandemic
Since the start of the pandemic, in addition to the US, central banks of Japan, the UK, and Euro area have added $10.2 trillion in security assets, letting total assets increase to over $25.9 trillion as of end of September 2021. The Pandemic also signaled a turning point for monetary policy in developing countries, where many central banks introduced QE for the first time. According to the International Monetary Fund, 27 central banks implemented QE - 10 in Africa, 9 in Asia, and 8 in Latin America and the Caribbean. For developing country central banks, the total asset purchases ranged from $0.3 billion to $30 billion.
Although it is difficult to isolate QE’s effects from other monetary policy tools and fiscal policy tools, there is broad consensus that it has been an effective tool to increase market liquidity and ease financial conditions on an international scale. Observing the spillovers of QE on developing countries that had not adopted QE , however, show that this boosted global liquidity may come with its downsides. As long-term interest rates remained zero in developed countries, many developing country governments and corporations began to borrow in the international capital market. This increase in external borrowing often led to exchange rate appreciation, making imports cheaper and exports more expensive, which negatively affected the balance of payments of many developing countries.
Potential pitfalls
Inflation: As money is added to the economy, the risk of inflation grows. A QE policy that does not spur economic growth but causes inflation could lead to stagflation, where both inflation rate and unemployment rate are high. To combat inflation caused by QE, central banks may adopt quantitative tightening, another monetary tool aimed at reducing liquidity in the economy.
Devalued currency: Because QE increases the money supply in the economy, it devalues domestic currency. This helps domestic manufacturers because exported goods are cheaper in the global market. However, a decreasing currency value makes imports more expensive, which increases costs of production and consumer price levels.
Unemployment: Although QE has proven to lower unemployment rate, unemployment rate itself does not provide the clearest picture of the labor market. For example, most of the new positions created after the Great Recession were low-paying jobs (restaurant, hospitality) rather than the high-paying jobs (manufacturing, mining, construction) that the Fed was hoping for. The number of people who gave up and no longer looked for jobs also increased to a historic record, artificially bringing the unemployment rate down.
Economic inequality: Since the US middle class households predominantly hold wealth in real estate, a recovery in housing prices through QE should theoretically benefit the middle class, compressing wealth distribution. However, areas where home prices declined the most during the Great Recession were unable to benefit from the lower interest rates; moreover, these same locations suffered large increases in unemployment. The benefits of QE on the housing market was realized unequally across regions in the US.
Behavioral: QE may create an economic environment that alters “rational” behavior. For instance, prolonged low interest rates may make low-risk savings through tools like market savings accounts and life insurance policies unattractive, which could discourage personal saving behavior.
Conclusion
Quantitative Easing has emerged as a critical monetary policy tool during periods of economic crisis, especially when conventional policies reach their limits, as demonstrated during the 2008 Great Recession and the COVID-19 pandemic. By injecting liquids into financial markets and lowering borrowing costs, QE has proven effective in stabilizing economies, encouraging credit flow, and stimulating aggregate demand.
However, QE is not without its downsides. The risks of inflation, devalued currency, and economic inequality underline the limitations of this policy. While QE has lowered unemployment rates, the quality of job creating and the uneven distribution of benefits across income groups raise concerns about its long-term societal impact. Proponents of QE point out the devastating social costs that would have ensued if, after exhausting conventional monetary policy, the Fed had not taken further action through unconventional monetary policy to stimulate aggregate demand, repair broken markets, and support economic recovery. Critics of QE argue that any benefits of QE are outweighed by its inherently regressive effects which benefit those at the top more than those at the bottom.
As a relatively new and unconventional economic tool with little data, it is difficult to draw concrete conclusions about the policy’s true effectiveness. Perhaps some of the unintended consequences of QE, particularly involving wealth inequality, could be mitigated if the Fed coordinated more closely with other regulatory, fiscal, and international policymakers.
