In the dark days of 2008 following the collapse of Lehman Brothers it looked to many like the global economy was facing an economic collapse on a scale not seen before in living memory.
In November of that year the Federal Reserve undertook its first round of unorthodox policy in the form of large scale asset purchases, commonly called Quantitative Easing (QE), in an effort to avert that disaster.
Six years later the Fed appears to have succeeded in preventing the Great Recession from becoming another Great Depression and the central bank is now poised to halt its QE program.
Here’s how Quantitative Easing helped change the nature of central banking:
The Fed has seen its balance sheet swell from $US900 billion in September 2o08 to around $US4.5 trillion in October 2014.
This has predominantly been due to purchases of US treasury securities and mortgage-backed securities (MBS). Over time the QE program has fundamentally changed not only the size but also the make-up of the Fed’s balance sheet.
It has also meant that the Fed plays a huge role in the markets that it targets. By 2013 Fed holdings accounted for over 20% of both the Treasury and the MBS markets.
Research from the Fed network has suggested that asset purchases helped lower mortgage interest rates, reduce corporate and government borrowing costs and prevented widespread corporate bankruptcies in the early stages of the crisis.
In launching QE3 Ben Bernanke was also keen to tie the success of the program to the unemployment rate, which stood at 8.1% at the time. Since then it has fallen to 5.9% — a level that many economists consider close to full employment.
However, the QE program has not been without its critics — though fears that asset purchases would stoke runaway inflation and currency debasement have proven way off the mark with consumer price inflation still below 2%.
Concern now is focused on the potential impact of QE withdrawal with the Fed looking set to end the third round of purchases this week. As Nomura pointed out in a recent note “financial conditions have tightened somewhat and, if this persists, could be a modest drag on the outlook.”
With falling oil prices providing a downside risk to the Fed’s inflation target it is highly likely that they will maintain a cautious stance and could reiterate that rates will stay low for a “considerable time”. Yet with GDP growth still on track to hit a trend rate of around 3% the risks to the US appear modest and, barring a shock, the tapering process that begun in December 2013 should finally be concluded.
As Larry Summers told Bloomberg: “We’ll live just fine without QE.”