QE Is The "Albatross" of Monetary Policy
Updated: Feb 14
Quantitative easing (QE) is the "albatross" of the current stance of monetary policy. Quantitative easing was a monetary tool created during the Great Financial Recession. Operating at the "zero" bound of official rates, the Fed found a new channel (QE) to provide monetary stimulus and liquidity to the economy and financial markets. QE was a new way of making money as the Fed bought bonds directly from the financial markets in exchange for cash, increasing the broad money supply.
The first quantitative easing program ran from 2009 to 2014. During that period, the Fed's balance sheet exploded to over $4 trillion from about $500 billion before the Great Financial Recession. The Fed started the second QE program when the pandemic hit. That boosted the Fed balance sheet to $8.8 trillion, more than twice the size after the first program.
Several studies have concluded that the first QE program was the equivalent of several hundred basis points of additional official rate cuts. The second program was as big or bigger in scale, providing monetary stimulus worth several hundred points of Fed easing.
Since QE never existed before, no one understands how this new tool would impact the effectiveness of monetary policy when policymakers tighten policy. But it should be symmetrical. That means as long as the scale of QE remains exceptionally large (Fed balance sheet still well over $8 trillion), it will probably take much bigger hikes, and to higher levels, in official rates for the stance of monetary policy to be as restrictive as when QE was not in place. (Note: If there are no negative consequences of QE it would then go down as the greatest invention in history)
How else can anyone explain the exceptional strength of the labor markets and historic low unemployment rate, accelerating bank lending, resilience in the equity and bond markets, and high inflation rates after nearly 500 basis points of official rate hikes, the most significant increase for a single year since the early 1980s without linking it to QE?
Remnants of QE are preventing the Fed from accomplishing its goal of reversing the inflation cycle. Risk assets should remain well-bid as long as the Fed fails to recognize the problem. But what happens when the Fed says they were wrong again?