Fed Balance Sheet Aiming at $9 Trillion

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on Nov 27, 2020

Updated: Dec 19, 2022

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Quantitative Easing or QE was born in the aftermath of the 2008-2009 Great Financial Crisis. Ben Bernanke, then Chair of the Federal Reserve (Fed), came up with the QE idea on the basis of simple logic – by buying the U.S. government debt, the Fed will actively contribute to lowering the yield on the yield curve.

Effectively, this means easing the monetary policy. Viewed as an unconventional tool, QE is applied when interest rates are close to their lower boundary.

Let me use an example. If the Bank of England (BOE) had an interest rate of 2%, it would not engage in QE. Say, a recession comes. Or the BOE sees inflation falling and wants to prevent deflation. To do so, the BOE lowers the interest rate. However, when the interest rate comes close to zero (the effective lower boundary), the bank may still want to ease. Unless it sets the interest rate negative, it has the option of engaging in QE.

Aggressive QE Throughout the World

The Fed’s experiment with the QE was quickly embraced by the developed world. Why not, considering the success the Fed has?

After using the QE for the first time, the Fed saw the U.S. economy bouncing. In fact, the last several years were characterized by strong growth and high employment. Moreover, inflation rose to the Fed’s target. Hence, success on all fronts, considering that the Fed had a dual mandate – to bring inflation to target (i.e., price stability) and to create jobs.

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Therefore, it is understandable that the model was quickly embraced by other central banks in the world. Yet, some controversies exist. One of the most powerful counter arguments is that not all countries have a similar system to the one in the States. Indeed, that is true. As such, using the same medicine on a different patient may not work, even though the symptoms are alike.

Fast forward to 2020, and the Fed did what it was supposed to do. New recession, same medicine. After all, if it worked once, the assumption is that it will work again. Maybe it will; we have all the reasons to believe that, as a precedent exists.

The only thing that scares most nowadays is the aggressivity of the QE. In only a couple of years, the Fed’s balance sheet will double. In contrast, the first rounds of QE after the Great Financial Crisis took years and years to deploy and to see the effects.

The risk is that inflation will bounce much harder than it did in the past, but what would the Fed do, faced with such an exogenous shock like the pandemic?

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