Quantitative Easing and the U.S Economy: Assessing the Impact

The financial crisis that began in July 2007 threatened to bring down financial and banking systems in major economies of the world, especially in the US, by late 2008. The disruptions in the financial sector caused a liquidity crunch and contractions in the supply of credit to the private sector. Some of the largest financial institutions were on the verge of collapse as mortgage markets melted down. With the crisis hitting the global market, the credit freeze spread across all the economies. As a result, there were sharp reductions in output and a rise in unemployment across all major economies.In the US, the central bank – Federal Reserve (Fed) – took initiatives to prevent the financial crisis by cutting the short-term interest rate in the third quarter of 2007. Thus, the central bank resorted to the traditional manner of implementing the monetary policy by lowering short-term interest rates when the economy was weak. Conventional central bank policies were implemented to bring down the short-term interest rates. This influenced the cost of uncollateralized overnight bank lending in interbank money markets. In the US, the interbank lending rate, known as the federal funds rate (Fed Rate), was used as a basis for many other interest rates in the economy. Under normal conditions, the central bank influenced the slope of the yield curve, inflation, and overall economic activity by adjusting the federal funds rates through buying and selling short-term government securities outright. Using these conventional tools at the beginning of the crisis, the country’s central bank pushed its short-term policy rates to very low levels. As a result, by early 2009, the rates came down to as low as zero or close to zero. ...