A Critical Look at Quantitative/credit Easing During the Great Recession in the Us

Yongzhi Liu        

Professor Gustavo Indart

ECO209

23 March 2016

A Critical Look at Quantitative/Credit Easing During the Great Recession in the US

In the wake of the worst financial crisis since the Great Depression of the 1930s, central banks around the world implemented aggressive expansionary monetary policy in an effort to combat the Great Recession. However, they soon found themselves out of ammo after cutting short-term rates to near 0%^[1].  The conventional monetary policy that involved central banks altering short-term interest rate and the level of money supply to stimulate the economy was ineffective as unemployment rate kept rising and deflationary pressure remained^[2]. The Federal Reserve^[3] then implemented the unconventional monetary policies of quantitative easing and credit easing which involved the purchase of large quantities of government bonds, corporates bonds (typically durations exceeding one year) and mortgage backed securities. Its central goal was to lower interest rates on longer term financial instruments to provide desperately needed liquidity and encourage lending (Prisecaru 27).  This paper will provide compelling evidence that the Fed was correct in the implementation of large scale quantitative easing and credit easing as the lower interest rate on longer term financial instruments benefited the US economy. The paper will also argue that unconventional monetary policies indeed benefited the middle class and that it is unwise to conclude quantitative easing failed due to the economy’s failure to meet inflation targets. I will first examine degree of impact quantitative and credit easing had on longer term government bonds and Treasury bills. Secondly, I will discuss how the policies lifted the economy by boosting aggregate demand, reducing unemployment rate and combating deflationary pressure. Lastly, I will defend the Fed by countering criticisms made against the agency.

 Quantitative easing was implemented several times after the fall of Lehman Brothers. The first round of quantitative easing (will be referred to as QE1) took place from November 2008 to March 2010 as the Fed injected a total of $1.75 trillion in the purchase of mortgage backed securities, agency debt and treasury securities (Chen et al. 289). The results were quite significant as shown by the research of many economists. The yields on 5-10 year bonds decreased by 20-40 bp^[4] and the yields for 10-year Treasury bonds decreased by a whopping 160 bp (Krishnamurthy and Vissing-Jorgensen 243). Mortgage rates “also dropped to as low as 5%” (Prisecaru 29). Gagnon et al. also show that the QE1 was successful and that the “overall size of the reduction in the ten-year term premium appears to be somewhere between 30 and 100 basis points” (39).  The second round of quantitative easing (QE2) was implemented between November 2010 and June 2011 as the Fed began the purchase of $600 billion longer-term treasury securities (Prisecaru 29). QE2 was less impactful than QE1, but still quite effective. The yields on 5 year bonds were lowered by 11-16 bp and 10 year bonds were lowered by 7-11 bp (Krishnamurthy and Vissing-Jorgensen 255). Swanson’s research shows similar results that QE2 reduced the long-term treasury yields by about 15bp (151). In addition to the decrease in interest rates, the first two stages of QE also increased 10-year expected inflation by 96-146 bp and 5-16 bp respectively. According to Krishamurthy and Vissing-Jorgensen, these signs were positive for average consumers because “real interest rate fell” (255). The final two rounds of quantitative easing were implemented between September 2012 to December 2013 and December 2013 to December 2014. QE3 reduced mortgage rates on 30-year and 15-year fixed rate mortgages and QE4 reduced mortgage rates during the first quarter of 2015 (Prisecaru 29). It is evident that the large quantitative and credit easing programs effectively lowered the yields on instruments the Federal Reserve were targeting.