Quantitative Easing How the Fed Responded to the 2008 Great Recession

Quantitative Easing Economic considerations Negative real GNP growth (-2% - +1%) Higher Unemployment (10-18%) Low interest rates – Fed Funds Rate near 0 Liquidity trap Congress reluctant to use Keynesian Fiscal Stimulus

Quantitative Easing Problem – Economic Recession/Depression Initially created by “bursting” of the financial/housing bubble Low interest rate policy by the Fed (Greenspan years of Great Moderation) Greater access to housing market for lower income individual Promoted by FHLB – lowered income/qualifying criteria for mortgages Mortgage backed securities Allowed financial institution that originated the loans to “sell” them in bundles (mortgage backed securities) to third parties Reduced the incentive for originator to check “credit-worthiness” of applicant

Quantitative Easing Potential Solutions for economic recovery Fiscal Stimulus Limited by Congress Monetary policy Typically increased Ms by buying short term bonds with cash printed by the Fed Repurchase lowers interest rates -> increasing Investment and thereby AD Increases Consumer Spending _> and thus AD But in a liquidity trap/zero lower bond Monetary policy largely ineffective in these conditions

Quantitative Easing Bernake’s solution Purchase longer term treasury certificates (>3 years) Purchase corporate debt Allows firms to use cash to expand and hire more workers, invest in new equipment Did it work? Lower interest rates for corporate debt Increases I -> AD Lower interest rates for mortgages Increased housing sales, new construction, increased demand for construction workers and products _> inc C -> inc AD

Quantitative Easing Bernake’s solution Purchase longer term treasury certificates (>3 years) Purchase corporate debt Allows firms to use cash to expand and hire more workers, invest in new equipment Did it work? Increased GNP (~2-3%) Decreased unemployment (12%->5%)