The Federal Reserve System is predominately responsible for U.S. monetary policy

Question

The Federal Reserve System is predominately responsible for U.S. monetary policy. Since the economic crisis of 2008 it has implemented a policy known as Quantitative Easing (QE). Please explain what QE is in general. How many rounds of QE has the FED implemented? What are the potential effects of such a policy? Since the Great Recession of 2008, do you believe they are doing an adequate job or not? Please respond with solid economic reasoning, not personal opinion which is not founded on any verifiable evidence.

Explanation / Answer

Monetary authorities can lower the credit spread by purchasing private assets. Such a practice raises the asset’s price and lowers its interest rate, thereby lowering the credit spread. This reduces the financial frictions. Aggregate demand shifts to the right and both output and inflation increases. The economy moves back to equilibrium. This is the process of quantitive easing

The Fed does not set the federal fund rate. It targets the range in which it expects the federal funds rate to float. Since it is able to influence the demand and supply of bank reserves through its open market operations, the Fed is able to come very close to hit this target range. Starting from September 2007, the federal funds target was brought down from 5.25% to a the zero lower bound range of 0% to 0.25% in December 2008

When the lowering of federal funds rate did little to stimulate the economy during the financial crisis of 2007-2009, the Fed decided to embark on a policy of Quantitative Easing (QE). Because the banks were not lending out their piled up reserves to households and firms, the Fed started its open market operations to buy various short term financial instruments including 10-year Treasury notes to keep their interest rate from rising. It also purchased mortgage-backed securities. The Fed’s aim was to keep the interest rates on home loans and mortgage loans low so as to stimulate demand for housing.

The Fed also started buying long term securities of billion dollars’ worth to further liquidate the market. All these measures indicate that the Fed was working through a broader spectrum of interest rates. It was not targeting one specific rate of interest but a set of different types of interest rates.

Federal Reserve’s monetary policy response to the crisis comprised of a wide range of collateralized lending programs, which were funded by monetization. These programs were temporary in nature. There was a move for the target policy interest rate toward zero, the zero lower bound. There was an aggressive yet pragmatic asset purchase program, a kind of quantitative easing. This response was also funded by monetization that created a medium-term inflation threat.

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