Question

After the Great Recession the Fed bought $2trillion worth of long run assetts (such as Quantitative Easing)

What is the Fed trying to accomplish with Quantitative Easing?

Why could Quantitative Easing cause harm to the Economy?

Why did that long run not materialize?

Answer 1

A more recent approach to dealing with a recession, quantitative easing was famously implemented to aid in the 2008 financial crisis in the U.S. In this initiative, the U.S. Federal Reserve increased the money supply through QE (multiple rounds of QE) by $4 trillion by buying up bonds and mortgages, among other assets.

The use of QE is largely credited with helping to turn the U.S. economy around and bring it out of recession. However, some unexpected side effects occurred that blur that finding, including the banks holding on to approximately $2.7 trillion in excess reserves, which means that this money did not find its way into the U.S. economy.

Japan has also used QE. In 1997, Japan experienced a recession due to the Asia Economic Crisis. The Bank of Japan initiated QE by buying bonds and then buying stocks and private debt at an attempt to turn the economy around. However, it became clear that in this instance, QE was not effective in rebooting the economy, as it continued to fall by almost $1 trillion over the next seven years.

The Fed trying to accomplish with Quantitative Easing:

Quantitative easing (QE) is a form of unconventional monetary policy in which a central bank purchases longer-term securities from the open market in order to increase the money supply and encourage lending and investment. Buying these securities adds new money to the economy, and also serves to lower interest rates by bidding up fixed-income securities. It also expands the central bank's balance sheet.

When short-term interest rates are either at or approaching zero, the normal open market operations of a central bank, which target interest rates, are no longer effective. Instead, a central bank can target specified amounts of assets to purchase. Quantitative easing increases the money supply by purchasing assets with newly-created bank reserves in order to provide banks with more liquidity.

• Quantitative easing (QE) is a form of monetary policy used by central banks as a method of quickly increasing the domestic money supply and spurring economic activity.
• Quantitive easing usually involves a country's central bank purchasing longer-term government bonds, as well as other types of assets, such as mortgage-backed securities (MBS).
• In response to the economic shutdown caused by the COVID-19 pandemic, on March 15, 2020, the U.S. Federal Reserve announced a quantitive easing program that amounted to over $700 billion

If central banks increase the money supply, it can create inflation. The worst possible scenario for a central bank is that its quantitive easing strategy may cause inflation without the intended economic growth. An economic situation where there is inflation, but no economic growth, is called stagflation.

Although most central banks are created by their countries' governments and have some regulatory oversight, they cannot force banks in their country to increase their lending activities. Similarly, central banks cannot force borrowers to seek loans and invest. If the increased money supply created by quantitive easing does not work its way through the banks and into the economy, quantitive easing may not be effective (except as a tool to facilitate deficit spending).

Another potentially negative consequence of quantitive easing is that it can devalue the domestic currency. While a devalued currency can help domestic manufacturers because exported goods are cheaper in the global market (and this may help stimulate growth), a falling currency value makes imports more expensive. This can increase the cost of production and consumer price levels.

Starting in 2008, the U.S. Federal Reserve started a quantitative easing program by increasing the money supply by $4 trillion. This had the effect of increasing the asset side of the Federal Reserve's balance sheet, as it purchased bonds, mortgages, and other assets. The Federal Reserve's liabilities, primarily at U.S. banks, grew by the same amount. The goal of this program was for banks to lend and invest those reserves in order to stimulate overall economic growth.

However, what actually happened was that banks held onto much of that money as excess reserves. At its peak, U.S. banks held $2.7 trillion in excess reserves, which was an unexpected outcome of the Federal Reserve's quantitive easing program

Quantitative Easing cause harm to the Economy :

1. It drives inflation much higher. This is the biggest concern around quantitative easing. As more money circulates through the economy, prices rise. Why? While the supply of money increases, the supply of goods remains the same. Thus, the competition for each good increases, leading to increased prices, which in turn leads to inflation. Excessive inflation leads to distortion of prices and incomes, and can cause an economy to operate inefficiently.
2. It creates havoc with international trade. Newly printed money can be used by the government and consumers to import new goods and services from other countries. These goods and services are more or less coming in for free. Sounds like a great deal, right? The problem is that sooner or later other countries end up getting sick of exchanging goods and services for what they feel are worthless sheets of paper. In other words, the value of the importer’s currency decreases, which can discourage exporters. For example, China stopped exporting valuable minerals to the U.S. due to its quantitative easing program.
3. Threat to the U.S. dollar. Many countries get frustrated with attempts at currency manipulation like quantitative easing. They feel that these practices reflect an inability by the country to generate real growth and to honor debts. For example, other countries have become weary of lending the U.S. more money. Also, the status of the U.S. dollar as the world reserve currency is in jeopardy, likely because of quantitative easing.
4. Benefits don’t outlast QE programs. When the central bank stops printing money, the recovery often gets put on hold, or worse, begins to reverse. Although the hope is that new consumer confidence will inspire a real recovery, many feel these programs are only a short-term fix. This effect is exhibited by the fact that stock markets often fall when it is announced or speculated that the quantitative easing program will be brought to an end.
5. Encourages debt. Another key worry about quantitative easing is that the increased money supply and low interest rates encourage additional borrowing by both consumers and businesses. While some debt can help stimulate an economy, wanton loans and excessive debt can further exacerbate an already fragile one. Moreover, quantitative easing can lead to an increased government deficit as was the case with the U.S. in 2010 when it actually reached its debt ceiling.

While quantitative easing programs can fuel the economy, they can also dig a country into a deeper hole. The key to a successful QE program is to strategically implement it just long enough to promote real and lasting improvement. Unfortunately, the ability to do so is much easier said than done