Question 1

How does quantitative easing work?

Accepted Answer

The Fed logs into its own computer, types new dollars into existence, and uses them to buy Treasuries and agency mortgage bonds from big banks. The Fed now owns the bonds. The banks now have cash, which shows up as reserves held at the Fed. That is the whole mechanical trick. The Fed did not raise taxes, did not borrow from anyone, did not ask Congress. It created a liability on its own balance sheet and bought assets with it. The hope is that banks, sitting on all that new cash, go out and lend it, that the extra credit shows up as business investment and home buying, and that the economy heats back up. The reality, as every chart of bank reserves from 2008 to 2019 will tell you, is messier.

Question 2

What does the Fed actually buy in QE?

Accepted Answer

Almost always two things. First, Treasuries: the same bonds the U.S. government sells to fund itself. The Fed buys them from primary dealers in the secondary market, which is a legal nicety that lets it claim it is not directly financing the Treasury. Second, agency mortgage-backed securities: the bundled mortgages that Fannie Mae and Freddie Mac guarantee. Buying MBS pulls down mortgage rates directly, because the Fed is the biggest and least price-sensitive buyer in the room. In the 2008 and 2020 programs the Fed also dabbled in commercial paper, corporate bond ETFs, and a few more exotic facilities, but the bulk of QE is Treasuries and agency MBS.

Question 3

How does QE create money?

Accepted Answer

It creates bank reserves, which is one particular kind of money. When the Fed buys a bond from a primary dealer, it credits the dealer's bank with new reserves at the Fed. Those reserves did not exist a second earlier. They are not printed paper. They are a ledger entry. Whether they turn into the kind of money that shows up in your checking account depends on whether the banks do anything with them. If the bank lends those reserves out, the loan creates a new deposit, and now the broader money supply has expanded. If the bank parks the reserves at the Fed earning interest, which is what most of them did post-2008, the money stays stuck in the plumbing and never reaches you.

Question 4

What is the money multiplier?

Accepted Answer

It is the textbook formula that tells you how much total deposits the banking system can create from a single dollar of reserves, given a reserve requirement. If banks must hold 10% of deposits as reserves, the multiplier is 10, and a $1,000 seed deposit theoretically turns into $10,000 of total bank money through the re-lending chain. Bank A keeps $100, lends $900, that $900 lands at Bank B which keeps $90 and lends $810, and the geometric series eventually converges. That is the slider above. The caveat, which every intro textbook underweights, is that the multiplier only works if banks actually want to lend. After 2008 they mostly did not, which is why QE's actual effect on the money supply was a fraction of what the formula predicted.

Question 5

What is the difference between QE1, QE2, and QE3?

Accepted Answer

QE1 ran from late 2008 through early 2010. The Fed bought roughly $1.75 trillion of Treasuries, agency debt, and mortgage-backed securities, aiming to unfreeze credit markets during the financial crisis. QE2 ran November 2010 through June 2011, a $600 billion Treasury-only program designed to push down long-term yields when inflation was drifting below target. QE3 started in September 2012 and was the open-ended one: $40 billion of MBS per month plus $45 billion of Treasuries, promised to continue until the labor market improved substantially. It ended in October 2014, by which point the Fed balance sheet had swollen to roughly $4.5 trillion from under $1 trillion pre-crisis. The 2020 pandemic program was QE on steroids, adding another $3 trillion in two months and taking the balance sheet past $8 trillion.

How QE actually works.

The money multiplier

QE, answered.

How QE actually works.

The money multiplier

QE, answered.

Get the briefing in your inbox.