Quantitative Easing in the Great Recession

1-What is quantitative easing?

Quantitative Easing is a monetary policy which aims to increase the money supply. This policy is also understood as an expansionary monetary policy, which intends to lower the interest rates, increase the size of investment and the general price level. However, this monetary approach or policy does not include printing of new banknotes, rather central bank purchases government and other securities to flood the financial institutions with the capital. As the supply of capital increases, the price of the loan (interest rate) decreases. It increases the size of investment in an economy, as more capital or funds are available at a low rate (Krishanamurthy & Foster, 2015).

2-What events led to the US Federal Reserve adopting this practice?

The Federal Reserve introduced Quantitative Easing during the Great Depression of 1929. The objective of the measure was to increase the general price level and investment. During the great depression, people expected prices to reduce further this expectation adversely affected aggregate demand. As the demand for the goods and services decreased, so did the size of the investment, which resulted in massive unemployment. However, the liquidity-trap did not allow this strategy to produce desired results, and therefore, the government introduced the Fiscal Policy for the first time (Krishanamurthy & Foster, 2015).

Quantitative Easing was not emphasized as an economic strategy since World War II until The Great Recession occurred (sub-prime mortgage crisis).

3-What are the differences between the three rounds of quantitative easing (QE)? Were they successful?

The Federal Reserve bought Mortgage-backed Securities in parts, and it did so when the interest rates were about to approach zero. The objective of Quantitative Easing was to fix the economy and the strategy was to buy mortgage securities. The Federal Reserve bought securities in three different phases, which were later recognized as Quantitative Easing rounds. Economists and the Federal Reserve assert that these points were predetermined, which makes this entire exercise unique. For instance, the first round of Quantitative Easing occurred in the year 2008, during which the Federal Reserve spent $6 billion. Only after three months, the second Quantitative Easing started. During this period too, $600 billion worth of securities were purchased (this included a $250-300 billion investment in treasuries). In the third round, which occurred in the year 2012, was different because Federal Reserve did not buy securities in bulk but rather in parts (monthly basis) (Krishanamurthy & Foster, 2015).

These rounds were partly successful; Obama Administration had to introduce a fiscal stimulus to meet the set objectives (they failed to make economy robust).

4-Has quantitative easing been successful?

Quantitative Easing was a component of monetary policy, which aimed to increase the general price level, investment, and employment without printing the money. Also, the policy also aimed to avoid a liquidity trap, which conventional monetary policy might have caused. From the study of the American economy, it is apparent that monetary policy intensified economic activity and played a part in reducing unemployment. However, it failed to increase wages/real income. Therefore, we can say that Quantitative Easing was partly successful (Krishanamurthy & Foster, 2015).

5-What are the benefits and drawbacks of this practice on banks and upon households?

Benefits

• Allows central banks to expand the money supply without printing money, which has adverse implications for the economy in the long run.
• Provides capital at low rates to households/investors.
• The process of Quantitative Easing intensifies economic activity and generates employment.
• The scale of buying of securities is large, which allows affecting the entire

Drawbacks

• New Capital makes commercial banks more reckless; recklessness was the cause of the sub-prime mortgage crisis.
• It reduces real income, as it intends to increase the general price level.
• It also adversely affects the exchange rate, which yields complications for the economy (Krishanamurthy & Foster, 2015).

Reference

Krishanamurthy, A., & Foster, T. (2015). Quantitative Easing in the Great Recession. Kellog School of Managment, 1-23.