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Article by Shivam Shah
Edited by Yihan (Bradley) Tian
Throughout this pandemic, the US government has gone through a process of quantitative easing (QE), in which it seeked to stimulate the economy through reductions in financial market volatility. As current quantitative easing measures continue, financial institutions have noticed a sudden influx of people buying substantially larger amounts of assets (i.e., mortgages) from the financial sector than they otherwise would have been able to acquire. This occurred during both the depths of the financial crisis in late 2007 and early 2008 and throughout the QE era.
This article examines the relationship between QE and private-sector investments. There are two important components: first, QE provided significant infusions of liquidity to the mortgage market, both directly via the Fed's purchase of treasury bonds and indirectly via the purchase of "mortgage-backed securities.” Second, QE opened up considerable new credit markets that would otherwise have remained closed to private lending. It's worth noting that during this period, even more important than such credit markets are private-sector banks, which are not being subjected to this QE liquidity influx. Given that banks are not subject to the liquidity regulations that the Fed was imposing on other entities (which included mortgage-backed securities), they were able to rapidly make loans that would not have been made had the Fed not been there to meet its lending limits.
So what impact did these additional liquidity injections have on private-sector lending, investment, and growth? Looking at the US Bureau of Labor Statistics (BLS)’s data through 2009, a year in which QE as an overall policy set was relatively loose, BLS data demonstrate that, in raw dollar terms, QE significantly increased private-sector investment in real residential construction, real commercial real estate, and related equipment by roughly $0.13 trillion, $0.12 trillion, and $0.08 trillion, respectively. Since this investment was generally from private-sector banks, this credit expansion would have been heavily restricted by the federal restrictions on banks' lending. In addition, BLS data show that, in the same timeframe, the government-supported QE programs (stimulus, in other words) provided nearly $2 trillion in aggregate investment. However, it is important to remember that a large portion of the QE credit expansion did not directly contribute to the actual expansion of private-sector lending. The increase in private-sector lending via QE as an overall policy was largely due to QE's effect on the Fed's balance sheet—and in particular, to its ability to sell Treasury bonds to the Fed. This was known as the "Federal funds rate targeting effect."
For both the effects of the Fed buying Treasury bonds and the effects of QE in aggregate, the observed effects were, for the most part, small and rapidly reversed themselves when QE's effectiveness in spreading inflation-sensitive asset prices through the economy was dramatically reduced. In this context, the Federal Reserve's ability to sell Treasury bonds to lower funds rate became important. The central bank is authorized to purchase securities through the Federal Reserve System with its base funds to lower the Fed funds rate target; in particular, the Fed can buy securities that it has previously purchased, back to the day of purchase. Selling Treasury bonds to the Fed in order to sell to the public directly is known as the reverse repo program.
Overall, Increased private-sector investment, more so than before and allowed, could lead to rapid aggregation of economic bubbles. Therefore, this relationship between QE and the private sector is important to monitor as it influences not only the stock market but also the financial security of the common public.