A Brief History of Quantitative Easing: 6 Years and 3.1 Trillion Dollars Later, How Has the Economy Performed?
In the fall of 2008, the US economy was on the brink of catastrophic financial collapse. With the burst of the subprime housing bubble, reputable financial institutions that held toxic assets were either acquired at a rock-bottom price or had gone into bankruptcy of one kind or another. Financial markets were sent into free-fall, as investors feared that the financial contagion of the collapsing housing market would spread. During a single day of trading on Sept. 29, 2008, $1.2 trillion was erased from the US stock market.
History Repeats Itself
Quantitative easing, or QE, in the US began against this backdrop. Economists who studied the Great Depression, like former Federal Reserve Chairman Ben Bernanke, believed that decisive intervention by the Fed was important for preventing the markets from descending into chaos. Beginning in November 2008, the Federal Reserve began purchasing large amounts of mortgage-backed securities and bank debt.
This morphine-like injection directly alleviated fear regarding the liquidity and value of these securities and also increased confidence regarding banks and other financial institutions that held large quantities of these toxic financial instruments. Instead of employing conventional monetary tools such as targeting interest rates, the extent of the crisis forced the Fed to venture into new territory with QE.
When the Federal Reserve announced the second round of QE in November 2010, the US economy was not directly threatened with financial collapse, but the economy was stagnating. This second round increased the value of reserves, in both Treasuries and other Fed-supported securities, held by corporations. The Fed hoped that increasing these reserves would stimulate spending and borrowing by corporations and consumers. Numerous economists and analysts opposed the second round of QE, citing the risks of an asset bubble or a currency war caused by a depreciating U.S. dollar.
In September 2012, the Federal Reserve began to publicly target employment rates along with its conventional inflationary targets. Then-chairman of the Fed Bernanke announced the third round of QE and promised to maintain these purchases while unemployment and inflation rates were above the threshold levels of 6.5 percent and 2.5 percent, respectively. This amount was eventually increased to $85 billion in December 2012.
The purpose of associating employment rate targets with QE is to provide forward guidance for the economy so that corporations and financial institutions are assured of continued monetary expansion and low interest rates.
The Jury is Still Out
6 years and $3.1 trillion later, how has the economy performed? On the employment front, it appears that the Federal Reserve has met its target. According to the Bureau of Labor Statistics, unemployment fell from 7.8 percent in September 2012 when QE3 was announced to 5.9 percent two years later. Inflation continues to be low and stable at 1.7 percent.
While unemployment and inflation rates are low, GDP growth continues to be sluggish. The World Bank reported that the U.S. economy grew by 1.9 percent in 2013, as compared to 2.8 percent in 2012 and 1.8 percent in 2011. With labor force participation rates at a 35-year low, however, experts have expressed skepticism about the apparent improvement in the labor market.
In addition, evidence of an asset bubble is mounting, albeit in the stock market instead of the housing market. Stock indices reached all-time record highs in November 2014. In fact, the Price-Equity ratio of the S&P 500 has increased by more than 46 percent since October 2011.
As investment manager Warren Buffett warned, the consequences of QE, particularly inflation and asset bubbles, may take decades to play out. In addition, it is nearly impossible to answer whether the American economy would have been better off without quantitative easing. Furthermore, because QE is an unconventional and relatively untried policy tool, there are few case studies or benchmarks to which to compare the effects of the Fed’s QE policy.