Explaining Quantitative Easing (QE)
It Allows Central Banks to Create Massive Amounts of Money
Quantitative easing is a nontraditional technique used by the Federal Reserve to stimulate the economy in times of crisis. It increases the money supply and lowers long-term interest rates, making it easier for banks to lend. This, in turn, spurs economic growth.
Learn more about quantitative easing, when it's been used, and its effects on the economy.
What Is Quantitative Easing (QE)?
Quantitative easing (QE) occurs when a central bank buys long-term securities from its member banks. The central bank adds new money to the economy by buying up these securities. Interest rates fall as a result of the influx, making it easier for people to borrow.
QE is a monetary policy tool, an expansion of the Fed's open market operations, which is how ther central bank influences the supply of money. Another tool is to lower interest rates. The Fed uses QE after it's lowered the fed funds rate to zero. The fed funds rate is the basis for all other short-term rates.
- Quantitative easing occurs when a central bank purchases long-term securities to boost the economy.
- QE expands the money supply and stimulates growth.
- The Fed used QE to combat the 2008 financial crisis.
- It also revived QE in response to the COVID-19 pandemic.
Only the Federal Reserve has this unique power in the United States. That's why some people say the Federal Reserve is "printing money."
How Quantitative Easing Works
The Federal Reserve gives its member banks cash in exchange for assets like bonds when it buys up securities. The extra cash can then be lent out.
The Fed also controls the banks' reserve requirement, which is how much of their funds they're required to keep on hand, compared to what they lend out. Lowering the reserve lets the banks lend out more of their money. More money going out increases the supply of money, which allows interest rates to fall. Lower rates are an incentive for people to borrow and spend, which stimulates the economy.
A bank lends any deposits above its reserves. These loans then get deposited in other banks. They keep only 10% in reserve, lending the rest. That's how $1 trillion in Fed credit can become $10 trillion in economic growth.
The Fed used quantitative easing in the wake of the 2008 financial crisis to restore stability to financial markets. It once again leaned on QE in 2020 in the wake of the financial fallout of the COVID-19 pandemic, growing its balance sheet to $7 trillion.
Other Ways QE Stimulates the Economy
Quantitative easing stimulates the economy in three other ways.
QE Keeps Bond Yields Low
The federal government auctions off large quantities of Treasuries to pay for expansionary fiscal policy. It increases demand as the Fed buys Treasuries, keeping Treasury yields low. (There's an inverse relationship between yields and prices with bonds.)
Treasuries are the basis for all long-term interest rates. Quantitative easing through buying Treasuries therefore also keeps auto, furniture, and other consumer debt rates affordable. The same is true for long-term, fixed-interest debt. It supports the housing market when mortgage rates are kept low, and low rates on corporate bonds make it affordable for businesses to expand.
QE Attracts Foreign Investment and Increases Exports
Increasing the money supply also keeps the value of the country's currency low. U.S. stocks are more attractive to foreign investors when the dollar is weaker, because they can get more for their money. A cheaper dollar also makes exports less expensive abroad.
QE Could Lead to Inflation
The only downside is that QE increases the Fed's holdings of Treasuries and other securities. For example, the Fed's balance sheet held less than $1 trillion before the 2008 financial crisis. That number had increased to almost $4.5 trillion by July 2014.
The more dollars the Fed creates, the less valuable existing dollars are. This lowers the value of all dollars over time, which then buys less. The result is inflation.
But inflation doesn't occur until the economy is thriving. The assets on the Fed's books increase as well, once that happens. The Fed would have no problem selling them. Selling assets would reduce the money supply and cool off any inflation.
QE Around the World
Japan was the first country to use QE, from 2001 to 2006. It restarted in 2012 with the election of Shinzo Abe as Prime Minister. Abe promised reforms for Japan's economy with his three-arrow program, “Abenomics.”
The European Central Bank (ECB) adopted QE in January 2015 after seven years of austerity measures. It agreed to purchase 60 billion in euro-denominated bonds, lowering the value of the euro and increasing exports. It increased those purchases to 80 billion euros per month.
In December 2016, the ECB announced that it would taper its purchases to 60 billion euros per month in April 2017. It ended the program in December 2018.
QE In the United States
The Fed launched four rounds of QE to fight the financial crisis in 2008. They lasted from December 2008 to October 2014. The Fed resorted to QE because its other expansionary monetary policy tools had reached their limits. The fed funds rate and the discount rate were zero. The Fed even began paying interest to banks for their reserve requirements. Quantitative easing became the central bank's primary tool to stop the crisis.
QE added almost $4 trillion to the money supply and the Fed's balance sheet. It was the largest expansion from any economic stimulus program in U.S. history until 2020. The Fed’s balance sheet doubled from less than $1 trillion in November 2008 to $4.4 trillion in October 2014.
QE1: December 2008 to June 2010
The Fed announced QE1 at the November 25, 2008, Federal Open Market Committee meeting. It would purchase $600 billion in bank debt, U.S. Treasury notes, and mortgage-backed securities (MBS) from member banks.
The Fed had bought $1.25 trillion in MBS by February 24, 2010. It also bought $700 billion of longer-term Treasuries, such as 10-year notes.
Some experts worried that the massive amount of toxic loans on its books might cripple the Fed like it did the banks, but the Fed has an unlimited ability to create cash to cover any toxic debt. It also was able to sit on the debt until the housing market recovered.
QE2: November 2010 to June 2011
The Fed announced on November 3, 2010, that it would increase its purchases with QE2. It would buy $600 billion of Treasury securities by the end of the second quarter of 2011. That would maintain the Fed's holdings at the $2 trillion level.
Some investors were afraid that QE would create hyperinflation, and they began buying Treasury Inflation Protected Securities (TIPS). Others started buying gold, a standard hedge against inflation. This sent gold prices soaring to a record high of $1,917.90 an ounce by August 2011.
Operation Twist: September 2011 to December 2012
The Fed launched Operation Twist in September 2011. This was similar to QE2, with two exceptions. First, it bought long-term notes as its short-term Treasury bills expired. Second, the Fed stepped up its purchases of MBS. Both "twists" were designed to support the sluggish housing market.
QE3: September to December 2012
The Fed announced QE3 on September 13, 2012. It agreed to buy $40 billion in MBS and to continue Operation Twist, adding a total of $85 billion of liquidity per month. The Fed did three other things that it had never done before:
- It announced that it would keep the fed funds rate at zero until 2015.
- It said that it would keep purchasing securities until jobs improved "substantially."
- It acted to boost the economy, not just avoid a contraction.
QE4: January 2013 to October 2014
The Fed announced QE4 in December 2012, effectively ending QE3. It intended to buy a total of $85 billion in long-term Treasuries and MBS. It ended Operation Twist instead of just rolling over the short-term bills. It clarified its direction by promising to keep purchasing securities until one of two conditions were met: Either unemployment would fall below 6.5%, or inflation would rise above 2.5%.
Some experts considered QE4 to be just an extension of QE3. Others called it "QE Infinity," because it didn't have a definite end date. QE4 allowed for cheaper loans, lower housing rates, and a devalued dollar.
The End of QE 2008-2014
The FOMC announced on December 18, 2013, that it would begin tapering its purchases as its three economic targets were being met:
- The unemployment rate was 7%.
- Gross domestic product (GDP) growth was between 2% and 3%.
- The core inflation rate hadn't exceeded 2%.
The FOMC would keep the fed funds rate and the discount rate between zero and one-quarter point until 2015, and below 2% through 2016. The FOMC announced on October 29, 2014, that it had made its final purchase. It would continue to replace these securities as they came due, to maintain its holdings at those levels.
On June 14, 2017, the FOMC announced how it would begin reducing its QE holdings and allow $6 billion worth of Treasuries to mature each month without replacing them. It would allow another $6 billion to mature each following month until it had retired $30 billion per month.
The Fed would follow a similar process with its holdings of mortgage-backed securities. It would retire an additional $4 billion per month until it reached a plateau of $20 billion per month being retired. It began reducing its holdings in October 2017.
QE was also used in response to the COVID-19 pandemic. The Federal Reserve announced on March 15, 2020, that it would purchase $500 billion in U.S. Treasuries. It would also buy $200 billion in mortgage-backed securities over the next several months.
The FOMC expanded QE purchases to an unlimited amount on March 23, 2020. Its balance sheet had grown to $7 trillion by May 18. Fed Chair Jerome Powell said he was not concerned about the increase to the Fed's balance sheet. Inflation was not an issue, and the Fed was able to hold onto any assets until maturity.
Quantitative Easing Worked
QE achieved some of its goals, missed others completely, and created several asset bubbles. First, it removed toxic subprime mortgages from banks' balance sheets, restoring trust and, consequently, banking operations.
Second, it helped to stabilize the U.S. economy, providing the funds and the confidence to pull the country out of the recession.
Third, it kept the interest rates low enough to revive the housing market. That's why QE1 was a success—it lowered interest rates by almost a full percentage point.
Fourth, it stimulated economic growth, although probably not as much as the Fed would have liked. It gave the money to banks, but they sat on it and used it to triple their stock prices through dividends and stock buybacks instead of lending them out.
QE didn't cause widespread inflation, as many had feared, but it did lead to asset bubbles by making money so cheap. An asset bubble is a dramatic increase in the price of an asset, such as housing, that isn't supported by the underlying value of that asset. The housing bubble spurred by QE caused home prices to soar, but the rising prices were disconnected from the actual values of the homes.