Overview of Module 4, Section 6: Quantitative Easing, regarding Quantitative Easing (QE) as implemented by the Federal Reserve, particularly during &after the 2008 Financial Crisis and during the COVID-19 pandemic.

Main Themes

1. Definition and Purpose of Quantitative Easing (QE)

• QE is described as credit easing without sterilization focused on a much larger range of assets, specifically those having long maturities.
• The primary goal during the Financial Crisis was to address the risk stemming from Asset-Backed Securities by purchasing them from banks &financial institutions.
• QE aimed to remove almost worthless assets off the banks’ balance sheets, significantly improving their risk profile and increasing bank Reserves to encourage lending.
• The underlying issue during the Financial Crisis wasn't a lack of Reserves but instead the extreme amount of risk on banks’ balance sheets due to the loss of almost all market value of their asset backed securities. Banks were hesitant to lend or borrow until these risky assets were off their books.

2. Implementation During the 2008 Financial Crisis

• The Fed initially implemented credit easing measures, acting as a wholesale lender to banks, sometimes with sterilization (keeping the money supply constant) and sometimes without (increasing the money supply).
• These initial measures provided temporary relief, as seen in the rise of S&P financials and the decrease in credit default swap spreads.
• However, the failures of institutions like Bear Stearns led to a rapid escalation of the crisis, and these initial tools proved insufficient.
• The Fed then moved to large-scale asset purchases (QE Round 1), primarily focusing on ABS.
• This took $1.1 trillion off the books of banks & other financial institutions around the world and significantly increased Reserves.
• As with most Fed policies, the strategy involved a gradual approach based on macroeconomic conditions. Subsequent rounds of QE (Rounds 2 and 3) continued to purchase assets to further ease financial conditions .

3. Quantitative Easing During the COVID-19 Pandemic

• Most of the COVID Quantitative Easing was in the form of Treasuries, Central Banks’ preferred monetary tool. More than $1 trillion dollars in Treasuries were purchased to inject massive liquidity into the system, along with some $200 billion in ABS.

4. Unwinding Quantitative Easing (Quantitative Tightening - QT)

• The Fed has started unwinding Quantitative Easing (i.e. Quantitative Tightening) by letting some of the assets mature (and not purchasing new debt with it) and selling some of the assets. This is equivalent to decreasing the money supply.
• Fed statements indicate QT is occurring by phrasing such as “the Fed continues to reduce holdings of Treasury Securities and agency debt and agency mortgage-backed securities.”
• The primary method of QT has been through the Fed selling its Treasuries. The Fed is proceeding more cautiously with selling ABS to avoid triggering a fire sale and causing prices to plummet again.

5. Transparency and Monitoring of the Fed's Balance Sheet

• The Fed publishes its balance sheet every week on Wednesdays. It can be accessed on the Fed website and through FRED.
• The balance sheet details Assets (like Treasury securities and Mortgage-backed securities) and Liabilities (like Currency and Reserves).
• Changes in these holdings, particularly in Treasury and ABS, reflect the implementation and unwinding of QE.

6. Risk and Considerations

• There is a moral hazard tradeoff when Central Banks intervene in markets in which investors accepted excessive risk without due diligence in order to obtain short-term gains.
• During the 2008 crisis, the systemic nature of the problem justified the intervention to prevent a global financial meltdown.
• There is significant political sensitivity towards a Central Bank purchasing industry-specific assets, particularly before a crisis is fully evident.