What is Quantitative Easing?

This term “quantitative easing is thrown around like it’s commonplace, but it really only came into widespread use after the financial crisis struck in 2008.

Typically, the Federal Reserve dictates monetary policy by manipulating the target of the federal funds rate. This is the interest rate banks receive to loan other banks money to meet their minimum reserve requirements, as dictated by the Fed. The federal funds rate influences the prime rate, which affects the cost of borrowing from mortgages to credit cards. We talk about this in terms of the Fed “cutting or hiking interest rates.”

Quantitative easing is a more extreme monetary policy that involves the Fed buying financial assets – primarily US Treasuries and mortgage-backed securities – on the open market using money that is created out of thin air. This process is sometimes referred to as “money printing.”

In effect, the Fed uses QE to inject new money into the financial system through the banks from which it purchases these assets. The banks can take this newly minted cash and lend it out. This increases overall liquidity in the financial system and theoretically stimulates lending and the broader economy.

QE is a significant source of inflation. 

A central banks can also manipulate the bond market through QE operations. When it buys bonds on the open market, it creates artificial demand. This pushes bond prices higher than they otherwise would be and conversely suppresses interest rates.

Debt monetization through QE allows the US government to borrow and spend more than it otherwise would by suppressing interest rates and holding down the government’s borrowing costs.

Four Rounds of QE

As the 2008 recession unfolded, the Fed lowered the federal funds rate to near zero in hopes that cheap borrowing costs would help stimulate the economy – but it didn’t work. Since the Fed can’t realistically set rates any lower than zero, many thought they were out of firepower. Instead, they introduced quantitative easing.

Federal Reserve Chairman Ben Bernanke launched quantitative easing for the first time (QE1) in 2008, calling it “credit easing.” In this operation, the Fed bought over a trillion dollars in toxic mortgage-backed securities, allowing big banks to remove these worthless assets from their balance sheets. The Fed hoped would the encourage the banks to lend out money again and ease the credit crunch. QE1 lasted until March 2010.

As the economy continued to stumble, the Fed began a second round of QE in November 2010. In this operation, the central bank bought loads of Treasury bonds. The goal was to push down long-term interest rates, thereby encouraging home-buying and other long-term capital investments. This operation put money into banks and credit institutions, ostensibly increasing the funds available for lending. This program was ended in June of 2011. Many banks simply held this cash on their balance sheet.

In September of 2012, the Fed announced QE3. In this operation, the Fed bought a combination of Treasuries and mortgage-backed securities. This round of QE ended in December 2012.

Through three rounds of quantitative easing after the 2008 financial crisis, the Fed increased its balance sheet by nearly $4 trillion.

During the pandemic, the Fed ran a massive quantitative easing program sometimes referred to as QE infinity. This blew the central bank’s balance sheet to over $8 trillion.

It is likely that the Fed will run additional QE operations during the next financial downturn.