Farewell to QE2

Jul 1, 2011

June has come to a close. With that also comes an end of the second round of quantitative easing, known as QE2.

QE2 started off small in August 2010 after the promising early-year economic numbers had turned south. At the August 10th FOMC meeting, the Committee agreed to re-invest proceeds from maturing mortgage-backed securities and agency debt into long-term Treasury securities. The move would hold the size of the Fed balance sheet constant, instead of having it shrink as it otherwise would. The idea was that increased Fed holdings of long-term Treasuries would push down long-term interest rates, hopefully to help promote economic activity and investment now.

The "re-investment" stage of QE2 was only a small step. In the three months between its start in August and the second phase of QE2 in November, Fed holdings of long-term Treasury bonds rose by about $70 billion. Because the economic outlook continued to deteriorate into the fall and the specter of deflation seemed looming, the Fed found itself willing to act with more force three months later.

On November 3, the FOMC announced a plan to buy $600 billion of long-term bonds through June 2011 in addition to the re-investments it had already started making. Considering the subdued inflation numbers in recent months, the Fed wanted to move inflation back towards its implicit target of two percent, so they felt an expansion of the balance sheet was necessary.

Overall, it was expected that the Fed would end up buying an additional $800-$900 billion over that time period. The Fed has just about met that target, increasing its holdings of long-term Treasuries by about $750 billion since November 3rd and $800 billion since early August. Since November, the size of the overall balance sheet has increased by roughly $600 billion as expected.

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What is the legacy of QE2? Certainly, the prospect of deflation has gone away, and inflation is running closer to the Fed's implicit target, so in attempting to achieve one part of its dual mandate, it has seemed to succeed. However, its impact on other economic indicators seems to have been limited, a point made in a well-publicized article back in April. Although hiring numbers this year have been improved compared to last fall, the improvement is not great and it is unclear whether the small progress is a result of QE2, the stimulus in the tax cut deal, or other factors. Others have defended QE2 (see here and, more recently, here) as having done what it was supposed to do--ward off deflation and boost financial markets--and that it shouldn't have been expected to bear the full burden of having to improve employment and growth numbers significantly.

As of right now, it does not seem as if QE3 is in the works. The FOMC did announce last week that it would continue re-investing its securities holdings as they mature to ensure the balance sheet does not shrink, but further expansion is not on the horizon yet. 

So, it seems we must bid farewell to quantitative easing. To continue to track changes in the Fed balance sheet, among other government efforts to stabilize the economy and financial markets, check out Stimulus.org.