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In: Economics

what is the impact of the quantitative easing on the US economy?

what is the impact of the quantitative easing on the US economy?

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Expert Solution

Quantitative easing

Central banks pursue quantitative easing as a form of expansionary economic policy. The goal is to stimulate borrowing and consumer spending in hopes of raising aggregate demand. It is performed in a similar manner to more traditional government bond purchase programs except that the central bank is buying financial assets from commercial banks and other private institutions. This strategy is implemented when short-term interest rates are near zero and standard monetary policy would be less effective.

When the Federal Reserve buys financial assets from another bank, it creates new money for the purchases. Theoretically, the banks can then lend out the new money to generate economic growth. This policy also has the added effect of lowering interest rates in the economy, since the supply of available funds has increased.

The most recent Federal Reserve minutes indicated that the U.S. central bank is preparing to reverse its experiment with quantitative easing (QE) by reducing the size of its balance sheet.

Although the eventual desire to reduce the size of the balance sheet is no real surprise, the timing was unclear. It now appears that the FOMC will begin reducing the balance sheet by year’s end.

By lowering bond yields and lifting price/earnings multiples, higher income families benefit. If home prices don’t rise, or if lenders prevent cash-out refinancing, the policy’s wealth impact would widen wealth gaps. Fourth, the support for financial asset markets could lead to valuation extremes and create fragile market conditions.

In practice, the effect from QE was rather mixed. We suspect that a whole generation of economists will write dissertations on the impact of QE. However, at this particular moment, we don’t have the benefit of this analysis. Instead, we will have to focus on what effect the balance sheet reduction will have on the economy and financial markets.

Over the past three decades, bear markets in equities are closely tied to economic recessions; in fact, the last major market decline absent of a recession was the 1987 crash. History also tells us that modern recessions occur for two reasons, a monetary policy mistake (policy is too tight) or a geopolitical event. Reducing the Fed’s balance sheet, given the degree of uncertainty surrounding the impact of QE, raises the odds of a policy error.

The impact of QE on the economy: QE appears to have done little for the economy. Economic growth has been stagnant and it isn’t obvious that low rates alone would not have yielded a similar outcome.


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