Quantitative Easing

What Is Quantitative Easing?

Quantitative Easing (QE) is an unconventional monetary policy deployed when conventional rate cuts have been exhausted — typically when the policy rate is already near zero. The central bank creates new reserves and uses them to purchase financial assets, most commonly government bonds and mortgage-backed securities, from financial institutions.

How It Works

When the Fed buys a Treasury bond from a bank, the bank's reserve account at the Fed is credited. That bank now holds more reserves and fewer bonds. The intention is that:

1. Bond prices rise (yields fall), reducing long-term borrowing costs across the economy
2. Banks, flush with reserves, are encouraged to lend more
3. Investors, displaced from bonds, reach for yield in riskier assets — the "portfolio balance" effect
4. The wealth effect from rising asset prices stimulates consumption

Historical Episodes

• QE1 (2008–2010): Crisis-era response to the GFC, focused on MBS to stabilise the housing market
• QE2 (2010–2011): $600B in Treasuries to prevent deflation
• QE3 (2012–2014): Open-ended, $85B/month, wound down via the "taper"
• QE4 (2020): Pandemic response — $120B/month, largest ever

Side Effects and Criticisms

QE inflates asset prices disproportionately benefiting wealthier households. It compresses term premium and can encourage excessive risk-taking. When wound down (see: Taper Tantrum 2013), it can cause violent repricing in interest rate markets. Critics also argue it distorts price discovery in bond markets.

The Exit Problem

Every QE cycle creates a bigger unwind problem. The Fed's balance sheet peaked at ~$9 trillion in 2022. Reducing it via Quantitative Tightening without causing market dysfunction is one of the defining macro challenges of the 2020s.