Friday, November 7, 2014

What is Quantitative Easing and was it successful?


During the 2008- 2009 Great Recession, the Federal Reserve tried to create stability within financial markets and spur economic activity. To do this, the Federal Reserve lowered interest rates. But as the Federal Funds rate neared zero, interest rates remained high due to fears of insolvency within companies and illiquidity within financial markets. To solve this divergence in interest rate spreads, the Federal Reserve pursued unconventional monetary policy such as Quantitative Easing.
 Quantitative Easing works by the Federal Reserve purchasing assets, such as Mortgage-Backed Securities, long-term bonds, or treasuries, from banks in return for cash. This results in the bank holding excess reserves that can be loaned out to create economic activity. (When the bank’s supply of money increases, interest rates go down because banks want to be able to loan out their money to make a profit.) Quantitative Easing also allowed the Federal Reserve to create liquidity within financial markets, which freed up investors capital.  
Last week, the chair of The Federal Reserve Janet Yellen declared the end of Quantitative Easing, as the economy has improved and unemployment figures have lowered. Though the economy has improved and interest rates have been at near zero levels for the last four years, Quantitative Easing has become a controversial issue. Some people believe that this program has created a bubble in equity markets, and that it will lead to high inflation and a jump in interest rates after the program has been ended. The S&P 500 has returned over 130% since the start of QE1. Quantitative Easing may have helped make stocks an appealing choice to investors because businesses are able to take advantage of the low interest rates and bonds were had very small returns, but it is hard to say if Quantitative Easing has created a bubble in the equities market. The Fed has expanded its balance sheet by almost $3.6 trillion dollars through monthly asset purchases, but QE should be looked at as an asset swap rather than an inflationary program. (See link at bottom for more info) The last criticism, interest rates will jump after this program has ended, may become true, but the Fed has said that it will keep interest rates at similarly levels after the end of QE.
Quantitative Easing has not created economic wonders by creating a fast growing economy, but it may have helped make the Great Recession less damaging. Yet, there are still many economic side affects that may come of Quantitative Easing.
During the Great Depression, the Federal Reserve failed to pump liquidity into the system and help failing financial institutions. This led to a deflationary spiral and economic collapse. During the Great Recession, the Federal Reserve did many controversial things, but it fulfilled its duty of trying to create liquidity and stability within financial markets.

Here is the link mentioned above: http://pragcap.com/mechanics-qe-transaction


I am still unsure whether Quantitative Easing was a successful program. Please comment below on what you think or any information that has led you to view it in a certain way