Fed Rejects QE4 Claims as Treasury Purchases Begin
By Nathan Tynan
On October 15th, the Federal Reserve began purchasing short term government bonds, known as treasury bills, in response to instability in financial markets last month. The move has led to speculation of a new round of quantitative easing, a practice where the Federal Reserve boosts the economy by purchasing assets. However, the Fed has rejected this characterization, with chairman Jerome Powell remarking that “in no sense is this QE.”
The Fed’s decision was motivated by a crisis by a crisis in repo markets on September 16th. In repo markets, financial institutions are able to lend each other money overnight, helping ensure smooth operation of the financial system. However, when institutions have less cash on hand, they become less inclined to engage in lending, causing interest rates to rise. Precisely this happened last month, with repo rates peaking at an astonishing 10%, far above the standard 2.2%. When the situation became sufficiently severe to push the federal funds rate to 2.3%, outside of the Fed’s target for the first time since 2008, the Federal Reserve Bank of New York, which is generally responsible for financial markets, injected money into the financial system, stabilizing repo markets.
While the crisis was likely instigated by institutions paying corporate income taxes, leading to a dip in liquidity, the Fed assessed that the problem also owed to long term policies, specifically relating to reserves. As the Fed has allowed its assets to mature without purchasing more from financial institutions, bank reserves have progressively fallen, from $2.8 trillion in 2014, to $1.4 trillion today. While the Fed initially believed that reserves could fall to $1.3 trillion with no issues, the recent crisis led them to instead believe that reserves must be increased through robust asset purchasing. This has led the Fed to start a regime of purchasing $60 billion per month in treasuries, with roughly another $20 billion a month of other assets.
Because of its resemblance to quantitative easing, this plan has generated controversy. Quantitative easing is a Fed policy tool meant to boost economic performance by encouraging lending, meaning that its effects ripple across the entire economy, not just repo markets. Because of this, the Fed has been quick to distance any association of this policy with quantitative easing. However, it’s worth noting that the cumulative monthly purchasing of $80 billion in assets per month highly resembles QE3, the most recent period of quantitative easing, which consisted of $85 billion in purchases per month. The new purchasing regime will also likely lead to a marked increase in reserves, given the Fed’s stated goals, resembling the increase in reserves observed with every QE period since the 2008 financial crisis. However, the Fed points to multiple differentiating factors, beyond a mere difference in intent. The Fed is not pairing these purchases with a cut in interest rates, limiting the impact on the wider economy. They’re also concentrating their purchases into short term assets, rather than long- term ones, which has been a defining characteristic of previous quantitative easing. Regardless of the Fed’s arguments, however, investors may still read the move as a change in attitudes at the Fed, especially in the context of speculation about a looming recession.