QE4: Explanation, Pros, and Cons

How QE4 Changed Fed History

Janet Yellen and QE4
Federal Reserve Board Chairwoman Janet Yellen answers questions at a news conference following a Federal Open Market Committee meeting September 17, 2015 in Washington, DC. Photo by Win McNamee/Getty Images

QE4 was the fourth round of Quantitative Easing established by the Federal Reserve. Through QE4, the Fed bought long-term U.S. Treasury notes using credit it simply created. It used its Trading Desk at the New York Federal Reserve Bank, buying $85 billion in Treasuries from member banks each month. Almost all banks are members of the Federal Reserve system. The program began in January 2013.

On June 19, 2013, the FOMC announced it would begin tapering purchases by the end of the year if it looked like economic growth, inflation and unemployment were on track to meet the Fed's targets.

For more on this announcement, see FOMC Meetings Summary.

As a result, the stock market tumbled and the yield on the ten-year Treasury note rose by 1%. The Fed delayed its tapering until December, 2013. It reduced purchases by $10 billion a month through at least February 2014. Newly appointed Federal Reserve Chair Janet Yellen announced she expected the tapering to continue as planned.

QE4 Is Unprecedented

This fourth round signaled a substantial change in Federal Reserve policy. First, Former Fed Chairman Ben Bernanke announced that it would continue until either one of two things occurred:

  1. Unemployment dropped below 6.5%.
  2. The core inflation rate rose above 2.5%.

This was the first time the nation's central bank targeted the unemployment rate. It meant the Fed was just as concerned with stimulating economic growth as it was with preventing inflation. Historically, the Fed had prioritized inflation-fighting more than job creation.

By being so specific in its target, the Fed almost guaranteed that easing would continue through 2013. That's because unemployment was 7.7%, and inflation below 2%, when the program was announced. This gave Congress and the President time to negotiate a solution to the fiscal cliff.

Second, Bernanke announced the Fed funds rate would stay at its current zero percent level until 2015.

Why did the Fed take such unusual actions? Bernanke was a big believer that managing expectations of the Fed's actions was probably more powerful than what the Fed actually did. That's because uncertainty is so devastating to businesses' ability to plan for the future. By announcing what he was going to do, and then doing it, Bernanke set a stable stage for economic growth.

The first Fed Chairman to demonstrate this was Paul Volcker. He tamed inflation by ceasing the stop-go monetary policy that had created it. Once businesses knew that interest rates would remain high, they stopped raising prices, effectively ending inflation. Bernanke was also unlike his predecessor, former Fed Chairman Alan Greenspan, who was very mysterious about his intentions. Bernanke also had to offset the uncertainty generated by political leaders, who were in a deadlock over how to resolve the debt ceiling crisis in 2011, and the 2012 fiscal cliff crisis.

QE4 Advantages

QE4 expanded the money supply, just like previous quantitative easing programs. By selling their Treasuries to the Fed, banks have more money to lend. They compete with each other by charging lower interest rates. Since loans are cheaper, more people can borrow to buy autos, furniture and even school loans.

Companies hire more workers to keep up with this added demand, further boosting income and even more demand.

A second, related benefit is that the lower Treasury yields also make mortgage rates lower. This helps boost the housing market, which will continue to recover in 2013 with QE4.

A third advantage is that QE4 will keep the value of the dollar lower. That's because it's just like printing money. The more dollar-denominated credit that's available, the lower the value of each dollar out there. A lower dollar value boosts U.S. stocks because they are now less expensive for foreign investors to buy.

This lower dollar value provides a fourth advantage from QE4 -- higher exports. American-made goods and services become cheaper to foreigners, who then buy more. This higher demand also creates U.S. jobs.

QE4 Disadvantages

Unfortunately, QE4 ended the Fed's Operation Twist program, which successfully ran since September 2011. With Operation Twist, the Fed used money it got when short-term Treasury bills came due to buy long-term Treasury notes. As a result, the rates on short-term bills rose, while the rates on long-term notes fell. The Fed ended Operation Twist simply because it sold all the short-term Treasuries it owned.

Another disadvantage of QE4, like other quantitative easing programs, is the potential to spark inflation. If the Fed overshoots its mark, and doesn't time the market correctly, then it might end up with too much money in the economy. This is one of the major causes of inflation.

It's more likely, however, that the Fed will have no problem selling its Treasuries when the time comes. The most important reason is that it will simply transfer them to its member banks, cutting back on excess reserves. Second, the Fed won't sell its bonds until the economy is on solid footing. Banks will want to transfer excess reserves to the Fed because they will want to see the Fed funds rate raised. Third, Treasuries are practically risk-free investments. They are always in demand by governments, pensions and others who value safety.

On June 14, 2017, the Fed said it will reduce its holdings so gradually it won't need to sell them. Once the fed funds rate reaches its target of 2.0 percent, the Fed will allow $6 billion of Treasurys to mature without replacing them. Each month it will allow another $6 billion to mature. It's goal is to retire $30 billion a month. The Fed will do the same with its holdings of mortgage-backed securities, only with increments of $4 billion a month until it reaches $20 billion. (Source: "Fed Unveils Plan to Shrink Its Balance Sheet," The Wall Street Journal, June 14, 2017.) 

Other QE Programs