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Updated on Monday, April 13, 2020
Quantitative easing effectively pumps money into the economy in an effort to encourage lending and borrowing. As the United States deals with the economic fallout caused by the coronavirus pandemic, quantitative easing is one of the levers the Federal Reserve is pulling to help stabilize the fragile state of the American economy.
What is quantitative easing?
A monetary policy first introduced in the U.S. in 2008, quantitative easing is a way that the Federal Reserve can give a boost to a fragile economy by increasing its money supply. To inject that needed liquidity, the Federal Reserve will typically make large-scale purchases of different types of government bonds — mainly Treasuries and mortgage-backed securities — from the open market, thus flooding financial markets with liquidity.
Typically, the main lever the Federal Reserve pulls when the economy needs a jolt is adjusting the federal funds rate. To boost spending and flush cash into a crippling economy, the Federal Reserve can cut the federal funds rate, which makes economic activity — like taking out a mortgage or purchasing a car — cheaper for consumers. In some cases, though, cutting the key interest rate is not a big enough boost for a drowning economy, which is when quantitative easing comes into play.
“The federal funds rate, the main policy tool, is now near zero — it can be cut a bit further, but not much,” said Harald Uhlig, a professor of economics at the University of Chicago. “Lower interest rates make liquidity cheaper and thus inject liquidity into the system, but with rates almost as low as they can go, additional tools such as quantitative easing are needed to inject needed liquidity.”
How does quantitative easing help the economy?
When the Federal Reserve purchases bonds from banks, they are essentially increasing the money supply that’s available in the economy.
The idea is that the banks — now flush with cash from the Federal Reserve’s large-scale purchasing of bonds — will offer lower rates to consumers and businesses that are looking to borrow, thus expanding lending opportunities and encouraging borrowing. Lower interest rates make it more affordable for consumers and businesses to borrow and spend money on large purchases like mortgages and cars. That type of spending in turn stimulates the economy.
Meanwhile, as the law of supply and demand dictates, when the supply of money goes up, its value goes down. Keeping the value of currency low makes stocks more attractive to foreign investors — spurring investing — while also often makes exports cheaper.
How the Fed is using quantitative easing during the coronavirus pandemic
As the coronavirus pandemic wreaks havoc on the financial markets, the Federal Reserve has stepped in and deployed quantitative easing on a massive scale. On March 15, the agency announced a $700 billion quantitative easing program to help insulate the economy from the damage done by the pandemic. The quantitative easing was expected to take the form of purchasing $500 billion worth of Treasuries and $200 billion of agency-backed mortgage securities.
On March 23, however, the Federal Reserve upped the ante. The agency announced that it would instead purchase an unlimited amount of Treasuries and mortgage-backed securities, and that it would buy assets “in the amounts needed.”
“People are concerned that they [the Federal Reserve] don’t have any ammunition left, and that’s right and that’s wrong,” said Allison Schrager, a senior fellow at the Manhattan Institute for Policy Research in New York City. “I don’t know if they have much ammunition to, say, stimulate the economy, but they certainly have enough ammunition to keep the financial markets functioning.”
To keep those financial markets stable and functioning, Schrager explains, the Federal Reserve is buying up bond assets.
“It is a real danger that those markets that are already having irregularities could completely freeze up, or rates could just jump at such a high level, that people cannot borrow in the way that they really need to now,” she said. “So that’s what they’re doing, is sort of putting a lot of liquidity into those markets, so that they continue to function. So they’re not so much stimulating demand or stimulating the economy, but they’re keeping financial markets functioning.”
How the Fed’s use of quantitative easing can help consumers
Tendayi Kapfidze, the chief economist at LendingTree, acknowledges that the Federal Reserve’s latest policies will not completely alleviate the economic challenges caused by the coronavirus pandemic. However, he says that it will enable consumers, companies and municipalities to better deal with the crisis and emerge on the other side in a position to participate in the economy once it recovers.
“Consumer financial markets should continue to function seamlessly. The Fed’s liquidity support means that the cost of credit should decrease,” Kapfidze said. “Consumers should take advantage of this by evaluating their debt profile and looking for opportunities to save.”
He noted that while a mortgage refinance is an obvious opportunity to explore, most types of consumer debt can be refinanced. For example, you could use a balance transfer or personal loan to refinance an existing credit card, or you could replace an auto loan with another auto loan or home equity loan.
Kapfidze acknowledged that “with so many moving parts, not every financial institution will react immediately or to the same extent,” though. “It’s more important than ever that consumers shop around and find themselves the best deal,” he added. “Doing so could save you thousands and help you weather this economic storm.”
Was quantitative easing successful in 2008?
The Federal Reserve first rolled out quantitative easing measures to help save a crippling American economy in 2008. Between 2008 and 2014, the Federal Reserve bought a whopping $3.7 trillion in bonds from financial markets.
Since that initial rollout, the Federal Reserve’s use of quantitative easing — and whether it worked — has been the subject of many debates. Quantitative easing has been widely criticized for essentially being a quick fix for deeper-rooted problems — like putting a Band-Aid over a deep wound — and critics have argued over the monetary policy’s overall effectiveness.
Common critiques and concerns of the use of quantitative easing include:
- The risk of inflation and bubbles. One common argument held by many critics is that a flood of cash can actually drive prices up, by causing inflation as demand outpaces supply.
- Devaluing of currency. While a cheaper dollar makes exports cheaper and attracts foreign investors, it also has downsides, like hurting the import industry.
- Doesn’t help the local economy. Many have questioned whether quantitative easing actually accomplishes what it’s set out to do, which is to help the local economy. Instead, critics argue that it benefits the wealthy who own the assets the government is buying up, exacerbating wealth inequality.
While quantitative easing is largely agreed to be a controversial monetary policy – and its overall effectiveness is often up for debate – many economists still agree that in response to the 2008 financial crisis, quantitative easing was an overall effective tool in lowering long-term lending rates.