Monetary policy is usually pretty dull stuff. But during the last six years, the Federal Reserve’s unprecedented quantitative easing program became a high-stakes economic experiment that generated a surprising amount of divisive political fodder.
The Fed first began QE, as it’s known, in November 2008, shortly after Lehman Brothers collapsed and the government began bailing out banks to prevent a full-blown financial panic. The Fed’s plan was to supercharge the economic stimulus it was trying to create through traditional maneuvers such as cutting short-term interest rates. Ben Bernanke, who was Fed chairman at the time, was an expert on the Great Depression and the misguided actions of the Fed during that period, which arguably made the depression worse. He was determined to play a more constructive role in helping the economy recover.
Under QE, the Fed would purchase bonds in the open market, to take relatively safe assets out of circulation and force investors to buy riskier assets such as stocks. That, in theory, signaled the Fed’s support for prudent risk-taking, to lure gun-shy investors back into financial markets and restart the flow of money after the crisis. It also pushed down long-term interest rates, because stronger demand for bonds means issuers can pay less to investors who buy them. With sales of homes, cars and other things plunging in late 2008, the Fed hoped cheap money would help lure skittish consumers back into the market.
But quantitative easing went on far longer than just about anybody anticipated back in 2008, with the Fed ultimately amassing a massive $4 trillion portfolio of bonds. The central bank, now led by Janet Yellen, made the last of its scheduled bond purchases this month and has now affirmed that QE is officially over. The debate over its effectiveness, however, will go on for years, as new economic data rolls in and unintended consequences of the program become apparent.
Most economists agree that QE provided the kind of short-term stimulus the Fed intended. “One thing that is undeniable is that its introduction succeeded in driving a major turning point in consumer and investor sentiment,” Patrick O’Hare of research firm Briefing.com wrote recently. Here’s how a few major economic indicators changed after QE began:
S&P 500 stock index: up 129% since Nov. 25, 2008, the day the Fed announced its first quantitative easing effort
Real GDP (adjusted for inflation): up 9.8%.
Unemployment rate: down 1 percentage point
Consumer confidence index: Up from 44.9 to 94.5 (Conference Board)
Average weekly earnings, adjusted for inflation: up 0.7%
Inflation rate: up from 1.1% to 1.7%
Auto sales: up 61%
Housing starts: up 56%
Average 30-year mortgage rate: down 1.9 percentage points
Those figures clearly reflect an economy that has improved since the dark days of the Great Recession—but they hardly settle the question of whether QE has been effective. It’s impossible to untangle how much of the improvement would have happened as part of the normal economic cycle and healing after a recession, and how much was directly due to Fed intervention. And some elements of the economy—especially wage growth—remain far weaker than they should.
The economy recovered faster after prior recessions when there was no QE at all, which has generated quixotic campaigns to “kill the Fed” and concern on Capitol Hill over whether the Fed is too powerful. While campaigning for the Republican presidential nomination in 2011, Texas Gov. Rick Perry called quantitative easing “treasonous” and warned that if Bernanke went to Texas, “we would treat him pretty ugly.” (Economists still haven’t figured out what Perry was talking about.)
Winners and losers
Still, QE has caused some collateral damage. Super-low interest rates have been great for borrowers but lousy for savers, with current rates on money-market funds and CDs so low they may as well be zero. QE arguably put a floor beneath stock prices, because the Fed showed a willingness to inflate the price of such assets. Investors who got the message cashed in on one of the best bull markets in history. But there were still a lot of retirees and other thrifty investors who chose to keep their money out of stock and in the safest possible assets after the 2008 crash. They’ve been big losers under QE.
Some economists also argue that super-low interest rates have compelled companies to borrow and hoard money—or use it for stock buybacks that benefit shareholders but nobody else—instead of investing it in ways likely to make the economy grow. And it’s not clear everything will go smoothly once interest rates start to go back up. “How do we wind down quantitative easing and normalize interest rates?” Mark Zandi, chief economist of Moody’s Analytics, testified before Congress earlier this year. “It is going to be tricky, and I’m sure there are going to be a few bumps along the way.”
The real test of QE will probably come down to inflation and whether there are any ugly surprises ahead. Fed critics have been squawking about the risk of runaway inflation since QE began, since buying vast sums of bonds does potentially put more money into circulation. But inflation hawks have been dead wrong the whole time, with inflation now so low — around 1.7% — that economists are more worried about deflation than inflation. While focused on the Fed “printing money” through QE, many inflation worrywarts have overlooked the importance of wages, which usually spike during periods of inflation and even contribute to it; for the past six years, however, wages have barely budged.
High inflation could still materialize, since economic trends often take years to play out. There could be other unforeseen aftereffects of quantitative easing, such as a stock-market pullback now that the Fed has stopped pumping helium into the market. But it seems more likely that QE will go out with less drama than it generated during its existence. If monetary policy becomes dull once more, the Fed succeeded.
The Federal Reserve’s experiment in quantitative easing is coming to an end
The Federal Reserve’s $3 trillion experiment in stimulating the nation’s economy is slated to come to an end this week — a sign of the central bank’s growing confidence in the recovery as well as a tacit acknowledgement of the limits of its powers to boost growth.
The decision to stop pumping money into the economy is expected to come when Fed officials wrap up their two-day meeting in Washington on Wednesday. The program, known as quantitative easing, was originally intended to be a one-time injection of money into a financial system in shock during the darkest days of the crisis in 2008. But over the past six years, the central bank has turned to the program to try to remedy everything from lackluster hiring to a moribund housing market.
The Fed’s continued reliance on the program highlights not only its commitment to lifting the economy, but also its misjudgments earlier on. The central bank was too optimistic about the recovery, and paused quantitative easing twice only to decide later that its earlier efforts had been too modest.
“In 2008, 2009, I did not expect this,” said Don Kohn, who was then vice chairman at the Fed and now is a senior fellow at the Brookings Institution. “I didn’t really anticipate the need to continue doing more.”
Still, Fed observers credit the central bank, first under Chairman Ben Bernanke and now led by Chair Janet Yellen, with ultimately sticking with its efforts to lift economic growth. Critics said the measures would undermine the dollar in global currency markets and unleash a wave of inflation, but neither has happened. Indeed, inflation has run below the Fed’s 2 percent target.
“It’s not been distracted by the criticism,” said Paul Sheard, chief global economist at ratings company Standard & Poor’s. “You sometimes may lose a little bit of nerve. They stuck to it.”
Today, the economy is enjoying roughly 3 percent annual growth and the unemployment rate has fallen below 6 percent. Yet millions of Americans still have been jobless for more than six months, and millions more hold part-time jobs when they want full-time work. Wages have barely budged.
Studies have shown that quantitative easing has reduced unemployment and pushed down mortgage rates. But Fed officials have had to temper any enthusiasm over those improvements with the recognition that the economy is far from healed.
“These developments are encouraging,” Yellen said of the gains in the job market in a speech this summer. “But it speaks to the depth of the damage that, five years after the end of the recession, the labor market has yet to fully recover.”
The Fed is not alone in charting the course for the nation’s economy. Though independent, it shares that task with the White House and Congress. But those arms of government essentially withdrew from the world of economic policymaking by the beginning of 2013, leaving the Fed alone to try to resuscitate an economy that some warned could be due for a decade or more of pain.
The Fed normally operates by changing its target for short-term interest rates. A higher rate puts a lid on the economy by encouraging saving and making it more expensive for businesses and households to borrow money. A lower rate helps boost growth as cheap money spurs demand.
In the 2008 crisis, the Fed first lowered its key interest rate to zero. It was the economic equivalent of flooring the gas — but it still wasn’t enough to launch the recovery out of the worst downturn since the Great Depression.
So in the fall of that year, the Fed launched round one of quantitative easing. The Fed was seeking to prevent the market for mortgage-backed securities from crumbling amid a massive selloff by investors as homeowners fell behind on their loans. The Fed stepped in to buy $500 billion worth of securities, essentially propping up the market by pumping it full of money. The central bank didn’t actually print money — as some critics have accused it of doing — but instead added to the reserves that banks hold at the Fed.
Even so, it was an aggressive move with what, at the time, seemed like a hefty price tag. And at first, policymakers sought credit. Then-Fed Chairman Ben Bernanke declared the economy was sprouting “green shoots” thanks to new stability in money market mutual funds and the nascent refinancing boom spurred by lower mortgage rates.
But while economists generally agreed that effort helped the country avert another depression, the swift recovery that has historically accompanied downturns remained elusive.
The Fed kept lowering its expectations for economic growth. And so officials found themselves returning to the pump time and again.
The Fed believed the type of massive bond purchases it deployed to salvage the mortgage market had the potential to support a broader swath of the economy. They could help reduce long-term interest rates, encouraging businesses and consumers to borrow and spend money. Lower rates could also force skittish investors to take new risks. And, most importantly, the boost to the recovery would hopefully translate into new jobs for millions of Americans.
What the central bank didn’t realize was how much stimulus it would actually take to make a dent.
The Fed eventually learned that “this is a low potency monetary policy instrument,” Sheard said. “You need to double-down or triple-down.”
The double-down clocked in at $600 billion and came in 2010. The buds Bernanke had predicted failed to bloom. By the time of the Fed’s annual summit in the Grand Tetons in summer 2010, the unemployment rate was still above 9 percent, a surge in hiring had evaporated and inflation was dropping.
“The incoming data suggest that the recovery of output and employment in the United States has slowed in recent months, to a pace somewhat weaker than most [Fed officials] projected,” Bernanke said in a speech at the conference. “I believe that additional purchases of longer-term securities … would be effective in further easing financial conditions.”
A few months later, the Fed announced it would pump another $600 billion into the economy by purchasing long-term Treasury bonds. The move was a hit on Wall Street, as stock markets cemented their steady climb out of the trough of the recession.
But the stimulus was starting to attract criticism both from inside and outside the central bank. Some were concerned that the run up in the size of the Fed’s balance sheet could eventually result in an outbreak of inflation. There were also fears that the central bank was distorting the financial marketplace and creating incentives for investors to take dangerous risks.
“Monetary policy is not Thor’s hammer. It is an awesome weapon. But it has limitations,” Dallas Fed President Richard Fisher said in a speech in late 2011. “If we deploy it incorrectly, we might level more than interest rates and destroy that which we seek to create. And if we let it fly too far from our grasp, we may never get it back.”
Dissent within the ranks of the central bank grew more frequent after decades of relative consensus. The critiques came not just from those who opposed the stimulus, but also from some of its most ardent supporters. They worried that the Fed hadn’t gone far enough. The $600 billion stimulus ended in the middle of 2011, just as improvement in the unemployment rate seemed to stall. Meanwhile, inflation was still subdued and hiring was stuttering.
“When the [short-term interest] rate is at zero, we’re faced with a set of bad options,” St. Louis President James Bullard said in an interview. “I did not think we would have to return to QE3.”
Bullard was using the nickname for the Fed’s third round of so-called quantitative easing — the triple-down. This time, the central bank was determined not to let the recovery slip again. There were no limits to the program when it was launched in fall 2012. The Fed promised to keep pumping money into the economy until it was convinced that the job market was healthy.
Once again, the announcement fueled a rally on Wall Street. The refinancing boom kicked into overdrive as mortgage rates hit historic lows. The country has added over 200,000 jobs a month this year, and the unemployment rate is closing in on what is considered a normal level.
But two years and more than a trillion dollars of stimulus later, there remain pockets of weakness that the Fed cannot seem to touch.
Central bank officials have repeatedly pointed to government spending cuts as counteracting their efforts to jumpstart the recovery. Wages have stagnated since the recession despite the bull market on Wall Street, prompting criticism that the central bank’s policies have primarily benefited wealthy households — a charge that causes some officials to bristle. And early this year, the economy unexpectedly shrank – an anomaly that forced the Fed to push back its forecast for a full recovery once again.
Officials struggled to decide when to call it quits. The first hints in spring 2013 that the Fed was considering scaling back its bond purchases sent markets into freefall. Long-term interest rates shot up, causing mortgage rates to jump a percentage point over a few months. The spike contributed to a slowdown in the housing market, undermining the Fed’s ability to a move lest it endanger the recovery. Officials finally announced in December that it would begin wrapping up the program.
“Whenever you get into something new, it really helps to have a clear plan for how to get back out again later,” said Andrew Levin, a research fellow at the International Monetary Fund who worked at the Fed for more than two decades.
Though the bond purchases are ending, the Fed is still maintaining its easy-money stance by keeping its target for short-term interest rates at zero. Still, the debate inside the central bank has shifted from boosting the economy to letting the recovery stand on its own. Whether it falters will be the ultimate test of the success of the central bank’s grand experiment.
“It’s not just measuring the benefits. It’s still important to see what the ultimate costs are going to be,” said Elizabeth Duke, a former member of the Fed’s board of governors. “You can’t really judge those until it’s completely unwound.”