The United States Federal Reserve (Fed) has two key policy goals: low unemployment and stable prices. It aims to keep inflation below 2% and unemployment rates at around 4%. Prior to the 2008 recession, the Fed achieved these goals using what we call “conventional” policy tools, which include something called “open market operations.” This term refers to the Fed’s act of purchasing and selling treasury bonds from commercial banks, which increases and decreases the reserves that commercial banks hold.
Before 2008, the Fed used open market operations to keep the federal funds rate within a target range, which hovered around 5%. After 2009, consumer spending was at an all-time low. In an effort to stimulate the economy, the Federal Reserve started using “quantitative easing.”
Quantitative easing occurs when a central bank purchases assets to bring interest rates below the target range, effectively trying to lower them to zero. The Fed used to only purchase enough assets to keep interest rates within their target range. However, to stimulate spending, the Fed wanted banks to hold more reserves, lowering interest rates and allowing more consumers to borrow from banks.
After the 2008 recession, the Fed issued quantitative easing efforts in three waves.
First, in November 2008, they announced that they would begin purchasing upwards of $600 billion from commercial banks. Most of these were mortgage-backed securities, which the Fed had never been in the market for. A mortgage-backed security is a bond that is secured by a bundle of real estate loans that are sold by the lenders. The second wave came in November 2010 when they announced their purchase of another $600 billion in assets that were almost entirely made up of long-term U.S. treasury bonds. The final wave in 2012 resulted in the purchase of about $85 billion in securities per month, which lasted until October 2014.
The Fed tried to return to a sense of pre-recession normalcy in 2015 when it began selling some of its mortgage-backed securities back to commercial banks. They slowly began raising target interest rates once again.
Then, the coronavirus-induced recession hit in 2020.
The Federal Reserve quickly dropped the target federal funds rates to zero. They purchased massive numbers of U.S. treasury securities that amounted to nearly $1.7 trillion. However, there was a problem—people simply did not want to spend money, despite the lower interest rates, because businesses were closing for health and safety concerns. Inevitably, national productivity fell in a sharp downward spiral.
As of November 2021, the United States economy is still propped up on quantitative easing efforts. In the next five to ten years, we will hopefully see the Federal Reserve begin to diminish the size of its balance sheet and sell off the assets it purchased to bring interest rates back to their standard amount and achieve low unemployment and stable prices.
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Sources
“Bonds | FINRA.org.” finra, https://www.finra.org/investors/learn-to-invest/types-investments/bonds/types-of-bonds/mortgage-backed-securities. Accessed 10 July 2023.
“Chronology of Fed's Quantitative Easing • Yardeni Research.” Yardeni Research, https://www.yardeni.com/chronology-of-feds-quantitative-easing/. Accessed 10 July 2023.
“The Federal Reserve's Dual Mandate.” Federal Reserve Bank of Chicago, 20 Oct. 2020, https://www.chicagofed.org/research/dual-mandate/dual-mandate. Accessed 10 July 2023.
“How the Fed Has Responded to the COVID-19 Pandemic.” Federal Reserve Bank of St. Louis, 12 Aug. 2020, https://www.stlouisfed.org/open-vault/2020/august/fed-response-covid19-pandemic. Accessed 10 July 2023.
“What Is Quantitative Easing (QE), and How Does It Work?” Investopedia, https://www.investopedia.com/terms/q/quantitative-easing.asp. Accessed 10 July 2023.
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