Federal Reserve Bank of St. Louis
The Federal Reserve significantly increased bank
reserves and the monetary base after Lehman
Brothers announced on September 15, 2008, that it
had filed for chapter 11 bankruptcy protection.
The Fed took additional steps toward quantitative easing (QE) on
March 18, 2009, when it announced that it would purchase
up to $1.725 trillion in mortgage-backed securities and
government and agency debt. Recent speculation that the
Federal Open Market Committee (FOMC) may purchase
an additional large quantity of government debt to stimulate
economic growth, increase employment, and prevent deflation
has prompted considerable debate over the effectiveness
of additional quantitative easing (QE2). This synopsis
analyzes some of the central issues in this debate.
One key issue is whether additional large-scale securities
purchases by the Fed would cause interest rates to decline
significantly. Recently Gagnon et al.1 used several methods
to investigate the effect of the FOMCâs announced securities
purchases ($1.725 trillion) on the 10-year Treasury yield,
which they estimate to be in the range of 38 to 82 basis
points. Some might conjecture that an FOMC commitment
to purchase, say, an additional $1 trillion in securities could
reduce the 10-year yield by a comparable amount (22 to
48 basis points). These estimates may be too large and
need to be confirmed by further research. Moreover, some
commentators (e.g., Narayana Kocherlakota, president of
the Minneapolis Fed2) have suggested QE2âs effect on
Treasury yields may be âmutedâ because financial markets
are functioning much better than they were in the spring
of 2009.
There is another reason that the effect on interest rates
could be small. Banks are currently holding about $1 trillion
in excess reserves rather than making loans and increasing
the supply of credit to the non-banking segment of the
credit market. It is possibleâperhaps even likelyâthat
almost all of any increase in the supply of credit associated
with QE2 simply would be held by banks as excess reserves.
If so, the effect of QE2 on interest rates could be small and limited to an announcement effectâthe effect associated
with the FOMCâs announcementâindependent of the
effect of the FOMCâs actions on the credit supply.
Even if QE2 did affect interest rates, many believe that
the effect on output or employment would be small.
http://research.stlouisfed.org/publications/es/10/ES1029.pdf
The Federal Reserve significantly increased bank
reserves and the monetary base after Lehman
Brothers announced on September 15, 2008, that it
had filed for chapter 11 bankruptcy protection.
The Fed took additional steps toward quantitative easing (QE) on
March 18, 2009, when it announced that it would purchase
up to $1.725 trillion in mortgage-backed securities and
government and agency debt. Recent speculation that the
Federal Open Market Committee (FOMC) may purchase
an additional large quantity of government debt to stimulate
economic growth, increase employment, and prevent deflation
has prompted considerable debate over the effectiveness
of additional quantitative easing (QE2). This synopsis
analyzes some of the central issues in this debate.
One key issue is whether additional large-scale securities
purchases by the Fed would cause interest rates to decline
significantly. Recently Gagnon et al.1 used several methods
to investigate the effect of the FOMCâs announced securities
purchases ($1.725 trillion) on the 10-year Treasury yield,
which they estimate to be in the range of 38 to 82 basis
points. Some might conjecture that an FOMC commitment
to purchase, say, an additional $1 trillion in securities could
reduce the 10-year yield by a comparable amount (22 to
48 basis points). These estimates may be too large and
need to be confirmed by further research. Moreover, some
commentators (e.g., Narayana Kocherlakota, president of
the Minneapolis Fed2) have suggested QE2âs effect on
Treasury yields may be âmutedâ because financial markets
are functioning much better than they were in the spring
of 2009.
There is another reason that the effect on interest rates
could be small. Banks are currently holding about $1 trillion
in excess reserves rather than making loans and increasing
the supply of credit to the non-banking segment of the
credit market. It is possibleâperhaps even likelyâthat
almost all of any increase in the supply of credit associated
with QE2 simply would be held by banks as excess reserves.
If so, the effect of QE2 on interest rates could be small and limited to an announcement effectâthe effect associated
with the FOMCâs announcementâindependent of the
effect of the FOMCâs actions on the credit supply.
Even if QE2 did affect interest rates, many believe that
the effect on output or employment would be small.
http://research.stlouisfed.org/publications/es/10/ES1029.pdf
