Quantitative Easing and the Fed

Unconventional Monetary Policy: QE

The unconventional monetary policy of quantitative easing (QE) brought about by the Federal Reserve in 2008 was meant to address the Great Recession triggered by the bursting of the housing bubble and the subprime blow-up. Three rounds of QE were initiated, the first from December 2008 to March 2010 in which $600 billion in agency mortgage-backed securities and agency debt were purchased by the central bank in order to add liquidity to the market, ease fears of a collapse, and stimulate the overall economy. In November 2010, the Fed began its second round of QE, this time buying $600 billion in Treasuries. The third round of QE was announced in 2012 and halted in October 2014 after the Fed had accumulated $4.5 trillion in assets on its balance sheet. Prior to the recession, the Fed held only $800 billion of Treasuries on its books. In order to stimulate the economy, the Fed had pumped nearly $4 trillion into the markets. The problem of recession was what QE was meant to solve—but, as Milton Friedman (2013) points, rapidly increasing the monetary supply in a brief amount of time is inflationary—and across asset classes the effects can be seen: the price of gold up, the price of homes up, the price of medicine up, the price of equities up, and so on.

The agents pushing QE forward were Fed Chair Ben Bernanke and his successor Janet Yellen. Bernanke and Yellen and most of the board members of the Fed believed that QE would be a helpful way to contain the risk bubbling to the surface as subprime imploded and banks like Lehman and Bear Stearns collapsed. However, their perspective was essentially formed by the idea that the American economy could not afford a hard crash: to many investors from pension funds to sovereign wealth funds were invested in the market; letting it fall further would cause untold losses. Thus, the Fed had to backstop the market by purchasing the debt that no one else wanted. This caused yields to fall and prices to rise. A bull market that has lasted a decade commenced.

Those against it were people like Ron Paul who actually published a book entitled End the Fed in 2009, the year following the introduction of the first round of QE. Others included G. Edward Griffin, who wrote the history of the Federal Reserve in Creature from Jekyll Island, which chronicled the birth of the Fed and its impact on the American economy, dollar, government and monetary policy. These two individuals and many people who joined the Libertarian Movement viewed the Fed’s actions as anti-free market and as a means by which the free market economy was turned into a command economy, with the Fed essentially determining prices.

The incentive framework of the main agents involved before the policy was implemented was limited to keeping inflation at 2% over the long term, ensure stable prices, and achieve maximum employment. QE appeared to add to its mandate the policy of not letting the market fall—or even correct. (The market has not seen a 20% correction since the launch of its bull run ten years ago—unheard of in any other bull market in history).