QE is a monetary policy tool, an expansion of the Fed’s open market operations, which is how it influences the supply of money. Other tools include lowering interest rates; the Fed uses QE after it’s lowered the fed funds rate to zero. (The Fed funds rate is the basis for all other short-term rates.) In the United States, only the Federal Reserve has this unique power. That’s why some people say the Federal Reserve is printing money.
How Quantitative Easing Works
In buying up securities from its member banks, the Federal Reserve gives them cash in exchange for assets, such as bonds. The extra cash then can be lent out. The Fed also controls the banks’ reserve requirement, which is how much of their funds they’re required to keep on hand compared to what they lend out. Lowering the reserve lets the banks lend out more of their money. More money going out increases the supply of money, which allows interest rates to fall. Lower rates are an incentive for people to borrow and spend, which stimulates the economy. The Fed used quantitative easing in the wake of the 2008 financial crisis to restore stability to financial markets. In 2020, in the wake of the financial fallout of the COVID-19 pandemic, the Fed once again leaned on QE, growing its balance sheet to $7 trillion.
Other Ways QE Stimulates the Economy
Quantitative easing stimulates the economy in three other ways.
QE Keeps Bond Yields Low
The federal government auctions off large quantities of Treasurys to pay for expansionary fiscal policy. As the Fed buys Treasurys, it increases demand, keeping Treasury yields low (with bonds, there is an inverse relationship between yields and prices). Treasurys are the basis for all long-term interest rates. Therefore, quantitative easing through buying Treasurys also keeps auto, furniture, and other consumer debt rates affordable. The same is true for long-term, fixed-interest debt. When mortgage rates are kept low, it supports the housing market. Low rates on corporate bonds makes it affordable for businesses to expand.
QE Attracts Foreign Investment and Increases Exports
Increasing the money supply also keeps the value of the country’s currency low. When the dollar is weaker, U.S. stocks are more attractive to foreign investors, because they can get more for their money. It also makes exports less expensive.
QE Could Lead to Inflation
The only downside is that QE increases the Fed’s holdings of Treasurys and other securities. For example, before the 2008 financial crisis, the Fed’s balance sheet held less than $1 trillion. By July 2014, that number had increased to almost $4.5 trillion. The more dollars the Fed creates, the less valuable existing dollars are. Over time, this lowers the value of all dollars, which then buys less. The result is inflation. Inflation doesn’t occur until the economy is thriving. Once that happens, the assets on the Fed’s books increase as well. The Fed would have no problem selling them. Selling assets would reduce the money supply and cool off any inflation.
QE Around the World
Japan was the first country to use QE from 2001 to 2006. It restarted in 2012 with the election of Shinzo Abe as Prime Minister. He promised reforms for Japan’s economy with his three-arrow program, “Abenomics.” The European Central Bank adopted QE in January 2015 after seven years of austerity measures. It agreed to purchase 60 billion in euro-denominated bonds, lowering the value of the euro and increasing exports. It increased those purchases to 80 billion euros a month. In December 2016, it announced it would taper its purchases to 60 billion euros a month in April 2017. In December 2018, it ended the program.
QE in the United States
In 2008, the Fed launched four rounds of QE to fight the financial crisis. They lasted from December 2008 to October 2014. The Fed resorted to QE because its other expansionary monetary policy tools had reached their limits. The Fed funds rate and the discount rate were zero. The Fed even began paying interest to banks for their reserve requirements. As a result, quantitative easing became the central bank’s primary tool to stop the crisis. QE added almost $4 trillion to the money supply and the Fed’s balance sheet. Until 2020, it was the largest expansion from any economic stimulus program in history. The Fed’s balance sheet doubled from less than $1 trillion in November 2008 to $4.4 trillion in October 2014.
QE1: December 2008 to June 2010
At the November 25, 2008, Federal Open Market Committee meeting, the Fed announced QE1. It would purchase $600 billion in bank debt, U.S. Treasury notes, and mortgage-backed securities (MBS) from member banks. By February 24, 2010, the Fed had bought $1.25 trillion in MBS. It also bought $700 billion of longer-term Treasurys, such as 10-year notes.
QE2: November 2010 to June 2011
On Nov. 3, 2010, the Fed announced it would increase its purchases with QE2. It would buy $600 billion of Treasury securities by the end of the second quarter of 2011. That would maintain the Fed’s holdings at the $2 trillion level. Some investors were afraid QE would create hyperinflation and started buying Treasury Inflation Protected Securities. Others started buying gold, a standard hedge against inflation. This sent gold prices soaring to a record high of $1,917.90 per ounce by August 2011.
Operation Twist: September 2011 to December 2012
In September 2011, the Fed launched “Operation Twist.” This was similar to QE2, with two exceptions. First, as the Fed’s short-term Treasury bills expired, it bought long-term notes. Second, the Fed stepped up its purchases of MBS. Both “twists” were designed to support the sluggish housing market.
QE3: September to December 2012
On September 13, 2012, the Fed announced QE3. It agreed to buy $40 billion in MBS and continue Operation Twist, adding a total of $85 billion of liquidity a month. The Fed did three other things it had never done before:
Announced it would keep the Fed funds rate at zero until 2015Said it would keep purchasing securities until jobs improved “substantially"Acted to boost the economy, not just avoid a contraction
QE4: January 2013 to October 2014
In December 2012, the Fed announced QE4, effectively ending QE3. It intended to buy a total of $85 billion in long-term Treasurys and MBS. It ended Operation Twist instead of just rolling over the short-term bills. It clarified its direction by promising to keep purchasing securities until one of two conditions were met: either unemployment would fall below 6.5% or inflation would rise above 2.5%. Some experts considered QE4 to be just an extension of QE3. Others called it “QE Infinity” because it didn’t have a definite end date. QE4 allowed for cheaper loans, lower housing rates, and a devalued dollar.
The End of QE 2008-2014
On December 18, 2013, the FOMC announced it would begin tapering its purchases, as its three economic targets were being met:
The unemployment rate was 7%.Gross domestic product growth was between 2% and 3%.The core inflation rate hadn’t exceeded 2%.
The FOMC would keep the Fed funds rate and the discount rate between 0 and .25 points until 2015 and below 2% through 2016. On October 29, 2014, the FOMC announced it had made its final purchase. It would continue to replace these securities as they came due to maintain its holdings at those levels. On June 14, 2017, the FOMC announced how it would begin reducing its QE holdings and allow $6 billion worth of Treasurys to mature each month without replacing them. Each following month, it would allow another $6 billion to mature until it had retired $30 billion a month. The Fed would follow a similar process with its holdings of mortgage-backed securities. It would retire an additional $4 billion a month until it reached a plateau of $20 billion a month being retired. It began reducing its holdings in October 2017.
QE 2020
The most recent use of QE was in response to the COVID-19 pandemic. On March 15, 2020, the Federal Reserve announced it would purchase $500 billion in U.S. Treasurys. It would also buy $200 billion in mortgage-backed securities over the next several months. On March 23, 2020, the FOMC expanded QE purchases to an unlimited amount. By May 18, its balance sheet had grown to $7 trillion. Fed Chair Jerome Powell said he was not concerned about the increase to the Fed’s balance sheet. Inflation is not an issue and the Fed is able to hold onto any assets until they mature.
Quantitative Easing Worked
QE achieved some of its goals, missed others completely, and created several asset bubbles. First, it removed toxic subprime mortgages from banks’ balance sheets, restoring trust and, consequently, banking operations. Second, it helped to stabilize the U.S. economy, providing the funds and the confidence to pull out of the recession. Third, it kept the interest rates low enough to revive the housing market. That’s why QE1 was a success: It lowered interest rates almost a full percentage point. Fourth, it stimulated economic growth, although probably not as much as the Fed would have liked. It gave the money to banks, but the banks sat on the funds. Instead of lending them out, banks used the funds to triple their stock prices through dividends and stock buybacks. QE didn’t cause widespread inflation, as many had feared. But it did lead to asset bubbles by making money so cheap. An asset bubble is the dramatic increase in price of an asset, such as housing, that isn’t supported by the underlying value of that asset. For example, the housing bubble spurred by QE caused home prices to soar, but the rising prices were disconnected from the actual values of the homes.
