Quantitative Easing
How the Fed Responded to the 2008 Great Recession
Quantitative Easing
• Economic considerations
• Negative real GNP growth (-2% - +1%)
• Higher Unemployment (10-18%)
• Low interest rates – Fed Funds Rate near 0
• Liquidity trap
• Congress reluctant to use Keynesian Fiscal Stimulus
Quantitative Easing
• Problem – Economic Recession/Depression
• Initially created by “bursting” of the financial/housing bubble
• Low interest rate policy by the Fed (Greenspan years of Great Moderation)
• Greater access to housing market for lower income individual
• Promoted by FHLB – lowered income/qualifying criteria for mortgages
• Mortgage backed securities
• Allowed financial institution that originated the loans to “sell” them in bundles (mortgage
backed securities) to third parties
• Reduced the incentive for originator to check “credit-worthiness” of applicant
Quantitative Easing
• Potential Solutions for economic recovery
• Fiscal Stimulus
• Limited by Congress
• Monetary policy
• Typically increased Ms by buying short term bonds with cash printed by the Fed
• Repurchase lowers interest rates -> increasing Investment and thereby AD
• Increases Consumer Spending _> and thus AD
• But in a liquidity trap/zero lower bond
• Monetary policy largely ineffective in these conditions
Quantitative Easing
• Bernake’s solution
• Purchase longer term treasury certificates (>3 years)
• Purchase corporate debt
• Allows firms to use cash to expand and hire more workers, invest in new equipment
• Did it work?
• Lower interest rates for corporate debt
• Increases I -> AD
• Lower interest rates for mortgages
• Increased housing sales, new construction, increased demand for construction workers
and products _> inc C -> inc AD
Quantitative Easing
• Bernake’s solution
• Purchase longer term treasury certificates (>3 years)
• Purchase corporate debt
• Allows firms to use cash to expand and hire more workers, invest in new equipment
• Did it work?
• Increased GNP (~2-3%)
• Decreased unemployment (12%->5%)