What is QE and why does it matter?

What is QE and why does it matter?

As a part of policy to rescue the economy from the ditch called COVID-19, the Trump administration declared unlimited QE back in March 23, 2020. The world was awed as it was an unprecedented decision to allow QE policy to be executed in an “unlimited” fashion.

As it is closely related to our investment, it is worth taking a note to find out what QE is and why that matters to our everyday lives.

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What is QE?

According to the balance, QE, or quantitative easing is a method that allows central banks to print massive amounts of money. This is how it works. First, a central bank buys long-term securities from its member banks. In return, the central bank issues credit to the banks’ reserve.

The interesting part of the question is this-where do central banks get the money to buy those securities? The answer is, out of thin air. They simply mint more money. In the United States, only the Federal Reserve has this unique power.

As the quantity of money in circulation increases while the actual value remains the same, QE influences a handful of rates that are significant in economic operation. One notable change it brings out is that it lowers the interest rate, which makes it easier to borrow money. As a result, QE often spur economic growth.

How does QE work?

Keywords: reserve requirement

Reserve requirement is the total amount of fund a bank is required to have at each night. The amount is a percentage of the bank’s total deposit, and the rate is set by the nation’s central bank.

The magnitude of economic stimulation expected from QE is far greater than the actual quantity of money newly printed at the Federal Reserve. Here is how it works. The Fed adds credit to a bank’s balance sheet that is greater than the reserve requirement. Then the bank lends the surplus to other banks. What happens is that each bank keeps only 10% in reserve and loan out the rest. In doing so, $1trillion in Fed credit can wield the magnitude of $10 trillion in economic growth.

QE 2020 and COVID-19

The most recent use of QE was in response to the COVID-19 pandemic. Initially, the FOMC declared a limited plan of $500 billion in the US Treasury and $200 billion in mortgage-backed security.

Jerome Powell, the chairperson of the Federal Reserve, had an interview with Today. In the interview, he was asked if there is a limit to the amount the Federal Reserve can put into QE policy. He answered that the amount can be increased as long as it supports the economic flow.

Perhaps reflecting his answer, the Federal Reserve updated the plan on March 23, 2020 to an unlimited QE.

Some think that the decision is quite remarkable considering Mr.Powell’s history of resisting President Trump’s request to lower interest rates despite receiving verbal assault. To a degree, this represents how serious of an economic blow the COVID-19 pandemic has been to the US economy.

What did the Fed act so unprecedentedly?

(The following opinion is taken from http://economicview.net/)

An analyst from an investment firm in Korea pointed out the Fed’s concern for the increased uncertainty in the Mortgage-Backed Securities (MBS) as the main driver behind Powell/s forward action. The analyst pointed out that the Fed bought back a large portion of MBS during the Subprime mortgage crisis back in order to get the economy back on track.

The MBS balance in the U.S. bond market is approximately $9.7 trillion, accounting for 22% of the U.S. bond market as of 2018, and is the second most important bond in the global bond market. The purchase of the bond by the Fed brought stability to the mortgage market in the United States. Currently, the Fed’s MBS balance is known to be about one third of the total balance. Since then, the Fed has been gradually reducing its weight to escape the highly unusual situation of one central bank holding such a huge portion of one type of bond that happens to be at the second highest status in a capitalist society. Unfortunately, the COVID-19 situation is putting Fed back in the wake of the massive purchase of bonds. The Fed, who slowly pulled its feet out of the swamp, has now put its feet back in.

High unemployment rate can deepen the wound.

As of May 27, 2020, Fed’s MBS purchases were $1,85 million, up 32% from the $1.44 billion at the beginning of the year. In other words, the MBS position that the predecessor had intended to settle someday was still in place, and when the COVID-19 pandemic arrived, the assets surged. The severity of the crisis may be more inclement as it can inflict further damage in the economy that has yet to be fully healed from the previous financial crisis. Workers who have to repay mortgages in the US are forced into large-scale unemployment again, and securities bought by the Fed can only be repeated in a vicious cycle of becoming bad debt again.

unemployment rate

Some hopeful sign for the current QE?

On the other hand, there is an interesting tweet analyzing the difference between the current quantitative easing and the quantitative easing of the past financial crisis. According to this analysis, the US Treasury bond position has increased significantly during the current QE. Therefore, if the Treasury uses these bonds for various programs, it can increase the amount of money flowing in the market, and have an economic stimulus effect.

Some worries that the QE may only increase the wealth disparity. And, in fact, if the tremendous amount of money is poorly used to fuel capitalists seeking to take advantage of the “disaster capitalism”, the Fed’s unprecedented effort to jump start the economy will only go in vain.

Powell, however, disgrees. He says that the current Fed Policies ‘Absolutely’ Don’t Add to Inequality. However, a lot of these issues actually depend on the policy makers. Adding to the Corona-19 pandemic, the recent development on the racial movement started by the death of George Floyd in Minnesota is becoming another big issue that needs attention. As the US government and economy are facing huge obstacles, we hope that the US government can take smart and timely action to guide the economy back on course.

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