On this page
Quantitative easing (QE) is an unconventional monetary policy tool where a central bank creates electronic money and uses it to buy government bonds, mortgage-backed securities, and other assets from banks and investors. It's used when traditional monetary policy (lowering interest rates) has exhausted its effectiveness because rates are already near zero.
When QE Is Used
Normal monetary policy relies on interest rates. The Fed lowers rates to make borrowing cheaper, stimulating spending and investment. But rates can't go negative in practice. When rates hit zero, the Fed has limited traditional tools.
During severe recessions or financial crises, zero rates aren't sufficient stimulus. Businesses and consumers are so scared they won't borrow even at zero rates. In these situations, the Fed uses QE: injecting money directly into the system by buying assets.
How QE Works
Step 1: The Fed announces a QE program. "We will buy $500 billion of mortgage-backed securities and $500 billion of government bonds over the next six months."
Step 2: The Fed creates new electronic reserves in its account with the Treasury.
Step 3: The Fed uses these reserves to buy securities from banks, insurance companies, and pension funds.
Example: Bank of America holds $1 billion of Treasury bonds. The Fed offers to buy them at market price. Bank of America agrees. The Fed credits Bank of America's reserve account with new money (electronically created). Bank of America loses $1 billion of bonds but gains $1 billion of reserves.
Step 4: Banks now have more reserves than required. They can lend this excess to other banks, buy stocks, or lend to businesses and consumers.
Step 5: The newly created money circulates through the economy, lowering long-term interest rates and boosting asset prices.
The 2008 Financial Crisis QE
When Lehman Brothers collapsed in September 2008, the financial system froze. Credit markets seized up. The Fed responded:
September 2008: Cut the federal funds rate to near zero
November 2008: Announced first QE program—buying $100 billion of mortgage-backed securities
December 2008: Expanded to $500 billion of government securities and mortgage-backed securities
2009: Continued buying, ultimately purchasing $1.7 trillion of securities
By 2010, the Fed owned roughly 20% of all mortgage-backed securities in existence.
This QE prevented financial collapse. By purchasing mortgage-backed securities, the Fed stabilized the housing market and reassured investors that the Fed had a plan. Asset prices eventually recovered. The economy slowly healed.
The COVID-19 QE
When the COVID-19 pandemic hit in March 2020, stock markets crashed. The Fed responded even more aggressively:
March 2020: Cut federal funds rate to zero
March 15, 2020: Announced unlimited QE—no cap on how much the Fed would buy
2020: Purchased $3+ trillion of government securities, mortgage-backed securities, and corporate bonds
This massive injection of money supported asset prices (stocks rose sharply despite economic shutdown) and kept credit flowing. But it also contributed to the inflation that followed.
QE's Effects
Positive effects:
- Prevents financial collapse (as seen in 2008 and 2020)
- Lowers long-term interest rates (mortgage rates fall, real estate prices rise)
- Boosts stock prices (asset owners benefit)
- Increases bank lending capacity (credit becomes available)
Negative effects:
- Benefits asset owners more than workers (stocks and real estate rise, but wages don't immediately rise)
- Can fuel inflation if too much money is created (as seen in 2021-2022)
- Creates moral hazard (banks and investors learn the Fed will bail them out, encouraging risk-taking)
- Increases wealth inequality (rich people own assets; QE benefits asset owners)
QE and Wealth Inequality
QE is highly controversial because it benefits asset owners disproportionately. When the Fed buys $3 trillion of securities, asset prices rise. Someone owning a $500,000 house gains $50,000+ in home value. Someone with $500,000 in stocks gains $50,000+. Someone with no assets gains nothing.
This is why QE is politically divisive. Policymakers argue it's necessary to prevent depression. Critics argue it's unfair to ordinary workers who don't own much real estate or stocks.
QE and Inflation
The 2020 QE + 2021 fiscal stimulus (government stimulus checks) combined to pump $5+ trillion into the economy. With supply chains disrupted and inflation expectations rising, this created the inflation spike of 2021-2022.
This raised a critical question: Did QE prevent depression or just delay the problem and make it worse? The answer depends on your perspective and assumptions.
Quantitative Tightening
QE is reversible. When the economy recovers, the Fed can sell assets (Quantitative Tightening, or QT), shrinking the money supply. Starting in 2022, the Fed began QT, allowing securities to mature without reinvesting the proceeds, slowly reducing its balance sheet from $9 trillion to $8+ trillion.
The Future of QE
QE has become a standard tool during crises. Every major central bank (European Central Bank, Bank of Japan, Bank of England) now uses QE in severe downturns.
The challenge is maintaining inflation control while supporting growth during crises—a difficult balance that QE alone can't achieve. Coordination between monetary policy (Fed) and fiscal policy (Congress spending) is likely critical during future crises.
