NCPA - National Center for Policy Analysis

The Fed and Quantitative Easing

April 28, 2011

The Federal Reserve's current monetary policy, known as Quantitative Easing (QE), consists of buying longer-term financial instruments, notably U.S. Treasury bonds and private mortgage-backed securities. Since the Fed engaged in one round of quantitative easing in 2008-2010, the current round (announced last November, but signaled for months prior) has been labeled QE2, says Ivan Pongracic Jr., an associate professor of economics at Hillsdale College.

  • QE2 is a departure from the Fed's usual procedures, which aim primarily to affect short-term interest rates through purchases of short-term (less than a year in maturity) Treasury bonds, or T-bills.
  • This tool of monetary policy, known as open-market operations (OMO), has largely been on the sidelines for the past two years, since the Fed drove the key short-term rate to near zero in late 2008 and has kept it there.
  • The Fed turned to QE that year because the Great Recession was so severe.
  • QE1 was primarily aimed at buying up mortgage-backed securities, many of which were considered "toxic" due to mortgages that were unlikely to be repaid
  • Astonishingly, through $1.75 trillion of such purchases, the Fed increased the monetary base (currency plus bank reserves) by nearly 200 percent between December 2008 and March 2010.

Rather than stimulating the economy through increased lending, much of that new money has remained idle, locked up in vaults as banks have been unwilling and often unable to lend.  Moreover, the Fed started to pay banks interest on their reserves held at the Fed.  This is why the massive increase in the monetary base has not brought about much increase in the active money supply (currency plus deposits), which is necessary to stimulate the economy.  This is also why the official inflation rate has continued to stay so low, says Pongracic.

Source: Ivan Pongracic Jr., "Quantitative Uneasiness," Freeman Online, May 2011.

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