The $4 trillion central bank program known as quantitative easing was intended to help the economy hit its full potential.
And no one doubts that the economy was, if not at full speed already, not far off from that. But a new paper suggests that QE did not provide the primary stimulus it was meant to — and that it contributed modestly to slower growth in inflation in the years after the program.
The problem was that the Federal Reserve was, in effect, paying for the assets it was buying, rather than taking them from the banking system. The central bank was taking advantage of low interest rates to buy bonds — Treasuries, agency debt, mortgage-backed securities — at a time when banks were, because of new financial regulations, less willing to sell. The Fed was buying these assets and holding them longer than it would have, in effect paying for the cash flows of the bonds it was buying.
The Fed has paid for $4 trillion of bonds without having that much money to spend.
No matter what the Fed did
The purchases probably did boost confidence and lower the interest rate spread between the bonds the Fed was buying and the interest rate the Fed was paying the banks. That would have reduced the cost of capital, and the return on capital, at the large companies that borrowed and invested, and thus made them more competitive and spur growth.
It is hard to know, given the Fed’s strict guidance and the squishy models used by economists to estimate the impact of unconventional measures on the economy, how much the Fed’s purchases may have helped the economy. What is clear is that they probably did not make up for the lack of credit available to firms and consumers.
So if they weren’t a step up, what was?
The more immediate benefit may have been to households and businesses. In particular, if firms and households were better able to borrow at lower interest rates, the effects on demand for homes and other items, growth in GDP and inflation would probably have been larger. The total effect of this would also be large. If prices had risen as much as the Fed had projected and the economy had accelerated toward full potential faster, then the costs of the Fed’s actions would have been larger than its benefits.
The Fed wanted the economy to be at full capacity
The Federal Reserve responded to the deep recession that followed the financial crisis, in 2008, by expanding its balance sheet by $2.5 trillion. Then it bought a further $4 trillion of bonds.
Part of that expansion was aimed at supporting a financial system that was still under stress. Another was aimed at increasing the amount of capital available for businesses and the stock market. A third was designed to boost consumer confidence. Finally, an additional $1.5 trillion — or so — was intended to restore near-full employment, after the Great Recession cut back the average for the six years before.
But why didn’t it work out?
The recession ended in June 2009. In the ensuing year, the unemployment rate fell, gradually — from a peak of 10 percent, reached in October 2009, to its current 6.7 percent. Inflation fell as well, moving from about 1 percent to less than 2 percent from late 2010 to mid-2014.
The overall impact was limited because the Fed could not, technically, increase the money supply to boost demand for labor. Instead, it lowered the discount rate it charged banks. That lowered the costs of capital and thus the return on capital. That reduced the cost of labor. As a result, even as the unemployment rate fell, the number of people being hired simply did not rise nearly as quickly as the Fed had expected. That’s why the Fed kept doing what it was doing.
So far, so good.
About the author:
Jeanna Smialek is a senior fellow in research at the Roosevelt Institute, specializing in the economy and education policy.