It’s the end of an era. The Federal Reserve System (Fed) has officially ended “quantitative easing,” the program of bond buying which began during the recession. The point of quantitative easing (or QE) was to inject liquidity into the economy in response to rapidly worsening economic conditions. As the Federal Reserve System purchased bonds, dollars were released into the financial system, helping push down interest rates in an effort to stimulate investment and consumption and, hence, help the economy recover. That’s an oversimplification of what is a more complex process, but that’s the gist of it.
When the financial markets began their downward spiral in the late summer of 2007, the total value of assets on the Federal Reserve’s balance sheet stood at about $900 billion. Between September 2007 and November 2008, the Fed’s bond buying push more than doubled assets to $2.2 trillion. By the summer of 2011 (after additional QE rounds of buying), asset levels approached $3 trillion, and by the end of 2013 hit $4 trillion. The latest data places assets at about $4.5 trillion. These assets include $2.4 trillion in US treasury securities and $1.7 trillion in mortgage-backed securities, among other things.
The concept of a trillion is difficult to latch onto, because the number is so large. It’s a million millions (1,000,000,000,000), and if you spent $1 million every day, it would take 2,739 years to reach a trillion. At present, the total market value of all goods and services produced within the US economy in a year is about $17.5 trillion, to provide another framework. A trillion dollars is a very big number, and it is bothersome to many people that the Federal Reserve now has 4.5 of them in assets. The rapid pace of the ramping up was also a cause for concern in that it took only a handful of years to blow through trillions.
The issue with injecting money into the system centers on the potential for inflation and the knowledge that the liquidity will have to be withdrawn at some point down the road. There are also criticisms that the inflows have artificially pushed up the value of equities by making bonds less attractive. More criticisms are that the influx also masked problems with banks and the financial system which should have been allowed to resolve themselves (even though that would have been painful).
These are valid concerns but a bit naïve with regard to the initial easing, although I’m glad to see the end of QE because it was time. However, these criticisms should be weighed against the fallout if no action had been taken. In a perfect world, such extreme measures would not be needed, but the US economy was in a sharp nosedive and the downside of QE was likely smaller than the downside of not intervening. The initial rounds of easing were absolutely essential, as the global financial markets were on the verge of collapse.
Between the fall of 2007 and late 2009, the US economy shed almost nine million jobs (from about 138.4 million to 129.7 million). Without QE, the losses would have been far worse. It took almost six years to get back to the number of pre-recession jobs, and I believe without QE it could have been much longer. With the recent stability in the economy, though, it was time to stop the program. The effectiveness of the later stages of the program can be legitimately debated, as monetary policy is not a particularly useful tool for ongoing stimulus. The program largely reflected the paralysis in Washington that prevented anything from getting done on the fiscal side.
Looking ahead, we’ll likely see the Fed keep the balance sheet around $4 trillion for a while, reinvesting proceeds from financial assets that mature. This will keep interest rates fairly low, encouraging capital investment. The end of QE does not equal the end of the Fed’s accommodative monetary policy stance. Until and unless inflation becomes a problem, there won’t be a lot of belt tightening at the Fed. The recovery is still not robust enough to risk backing off too far too fast and sending the US backsliding toward a recession. Rather, the Fed will pursue a slow course toward a slow return to more normal conditions.