Quantitative Easing and the U.S Economy: Assessing the Impact

Case Code: ECON050
Case Length: 12 Pages
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Pub Date: -
Teaching Note: Available

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Countries : USA
Themes: Quantitative Easing

Excerpts

Background

The financial crisis that began in July 2007 threatened to bring down financial and banking systems in major economies of the world, especially in the US, by late 2008. The disruptions in the financial sector caused a liquidity crunch and contractions in the supply of credit to the private sector. Some of the largest financial institutions were on the verge of collapse as mortgage markets melted down. With the crisis hitting the global market, the credit freeze spread across all the economies. As a result, there were sharp reductions in output and a rise in unemployment across all major economies.In the US, the central bank – Federal Reserve (Fed) – took initiatives to prevent the financial crisis by cutting the short-term interest rate in the third quarter of 2007. Thus, the central bank resorted to the traditional manner of implementing the monetary policy by lowering short-term interest rates when the economy was weak. Conventional central bank policies were implemented to bring down the short-term interest rates. This influenced the cost of uncollateralized overnight bank lending in interbank money markets. In the US, the interbank lending rate, known as the federal funds rate (Fed Rate), was used as a basis for many other interest rates in the economy. Under normal conditions, the central bank influenced the slope of the yield curve, inflation, and overall economic activity by adjusting the federal funds rates through buying and selling short-term government securities outright. Using these conventional tools at the beginning of the crisis, the country’s central bank pushed its short-term policy rates to very low levels. As a result, by early 2009, the rates came down to as low as zero or close to zero. ...

Phase of QE

From 2008 onward, the Fed under the chairmanship of Bernanke pursued QE for reviving the crisis-hit economy. Though Bernanke called that credit easing, the label did not stick and it was broadly accepted as quantitative easing. Based on the chronology, the QE measures were popularly known as QE1, QE2, and QE3. Such a non-conventional measure was the biggest emergency economic stimulus in the history of the US economy...

Impact on the US Economy

Most economists believed that QE had helped to avoid a catastrophic failure of the U.S economy. To some extent, the three phases of QE had spurred credit and liquidity in the market and had supported economic growth. However, some experts opined that the risk associated with QE was greater than the benefits derived from it. For example, when QE2 was initiated, the Kansas City Fed President, Thomas Hoenig, held a different opinion from other policymakers, and believed that the risks of additional securities purchases would outweigh the benefits. Similarly, Paul Ashworth, senior U.S. economist with Capitol Economics, said, "I don't think this is going to make any difference at all…This is a slippery slope. Once you're on it, it’s very hard to get off."..

The Other Side of QE

Analysts believed that the impact of QE on the overall economy was hard to assess; their views remained divided on quantitative easing. While the Fed and its supporters felt that the bond-purchasing program had led to a reduced cost of mortgage loans and corporate debt, and contributed to faster job growth, other economists blamed the Fed for exacerbating economic inequalities by helping to lift only financial markets while the rest of the economy was still weak. Some researchers too believed that QE had failed to bring major economies out of stagnation. They concluded that QE produced a limited and temporary gain for the financial sector and prevented the recession from becoming a depression. Further, it was believed that QE averted a financial collapse but the overall impact of QE was mixed – with some positive and some risky effects...

Outlook

There had been growing concerns about the quantitative easing measure being an experimental policy. Apart from the U.S, the scheme of bond-buying was undertaken by the central banks in the Eurozone and in Japan. Industry experts opined that such schemes could have a destabilizing effect on the economy if they were not backed by structural reforms. The IMF in its Global Financial Stability Report stated, “Failure to support current monetary policies will leave the economy vulnerable and risks tipping it into a downside scenario of increased deflation pressure, a still-indebted private sector, and stretched bank-balance sheets."..

Exhibits

Exhibit I: Transmission Channels of Quantitative Easing
Exhibit II: US Inflation Rate
Exhibit III: Yields of Treasury Bonds (10-year, 20-year, and 30-year of Maturity)
Exhibit IV: Average Unemployment Rate in U.S
Exhibit V: The U.S’s Federal Reserve Balance Sheet
Exhibit VI: GDP of US Economy

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