Helping consumers in a crisisJune 25, 2020
A new study shows that the central bank tool known as quantitative easing helped consumers substantially during the last big economic downturn — a finding with clear relevance for today’s pandemic-hit economy.
More specifically, the study finds that one particular form of quantitative easing — in which the U.S. Federal Reserve purchased massive amounts of mortgage-backed securities — drove down mortgage interest rates, allowed consumers to refinance their house loans and spend more on everyday items, and in turn bolstered the economy.
“Quantitative easing has a really big effect, but it does matter who it targets,” says Christopher Palmer, an MIT economist and co-author of a recently published paper detailing the results of the study.
All told, the study finds, the Fed’s so-called QE1 phase from late November 2008 through March 2010, a part of the larger quantitative easing program, generated about $600 billion in mortgage refinancing at lower interest rates, bringing about $76 billion worth of additional spending back into the broader economy.
However, as the study also demonstrates, the people benefitting from QE1 were a relatively circumscribed group of mortgage holders: borrowers from the Government Sponsored Entities (GSEs) Fannie Mae and Freddie Mac. So while observers may talk about quantitative easing as a “helicopter drop” of money, scattered across the public, the Fed’s previous interventions were relatively targeted. Recognizing that fact could shape policy decisions in the future.
“It’s not like the Fed drops money from a helicopter and then it lands randomly and uniformly and equally across the population, and people pick up those dollars and spend money and are off to the races,” Palmer says. “The Fed intervenes in specific ways, and specific people benefit.”
The paper, “How Quantitative Easing Works: Evidence on the Refinancing Channel,” is published in the latest issue of the Review of Economic Studies. The authors are Marco Di Maggio, an associate professor at Harvard Business School; Amir Kermani, an associate professor at the Haas School of Business at the University of California at Berkeley; and Palmer, the Albert and Jeanne Clear Career Development Assistant Professor at the MIT Sloan School of Management.
Mortgage relief for some
The introduction of quantitative easing during the Great Recession was a notable expansion of the tools used by central banks. Rather than limiting its holdings to treasury securities, the U.S. Federal Reserve’s purchase of mortgage-backed securities — bonds backed by home loans — gave it more scope to boost the economy, by lowering interest rates in another area of the bond market.
The first round of quantitative easing, QE1, which began in November 2008, included $1.25 trillion in mortgage purchases. The second round, QE2, which started in September 2010, focused exclusively on treasury securities. The third round, QE3, was initiated in…