Since late 2008, the Federal Reserve has engaged in a range of extraordinary monetary policy measures aimed at bolstering the economy. Among the tools deployed is what has been termed “quantitative easing” or “QE.” Briefly, QE entails the Fed’s purchasing longer-term securities, as Fed Chairman Ben Bernanke recently told the Congress, “to support economic growth by putting downward pressure on longer-term interest rates.” At present, the Federal Reserve is purchasing $40 billion in mortgage-backed assets and another $45 billion in longer-term Treasury securities each month for an indefinite period.
Students of economics have now had sufficient time to begin to evaluate some of those measures. Since the recession hit bottom, there have been three rounds of QE. In addition, each earlier round expired prior to the introduction of a succeeding round. Hence, one could gain some insight into both the impact of QE and the possible impact following the termination of QE.
Although QE is a non-traditional monetary policy tool, economic theory provided some insight into its effects. QE is an indirect measure aimed at stimulating macroeconomic growth and job creation. It stimulates the economy by lowering long-term interest rates (reducing the cost of capital for firms and increasing their economic profits) and through the “wealth effect” resulting from a boost in asset prices. Under the wealth effect, some share of the increase in asset prices ultimately impacts aggregate demand, largely through personal consumption expenditures. Given its indirect linkages to the real economy, one would expect that QE would have a more pronounced impact on asset prices and a more modest impact on macroeconomic growth.
The early experience has confirmed what one would reasonably expect from economic theory. QE has had a more visible impact on asset prices than the real economy. Fiscal stimulus would likely have a larger impact on the real economy, particularly high-multiplier expenditures and investment that flows directly into GDP.
Its termination, albeit for only temporary periods, had a more visible impact on asset prices, as well. Even as asset prices turned down, economic growth persisted at a steady but sluggish rate. Many additional factors ranging from ongoing deleveraging to headwinds from the European debt situation also impacted the rate of economic growth.
The charts below depict indexed values for the S&P 500 (a proxy for asset prices) and nominal GDP since the first quarter of 2009 when equities bottomed out. Nominal GDP is used, because equities prices are stated in current dollars.
Down the road, one can expect numerous papers to be written on QE. However, at this time, the emerging evidence shows that QE is behaving in a fashion not dissimilar from what one would expect from the existing economic literature.