In September 2008, the Federal Reserve initiated a series of quantitative easing (QE) programs that dramatically transformed the Fed's balance sheet--in size, liability mix, and asset mix. The "exit strategy" questions now facing the Fed, and the dollar-using public who are its captive customers, are when and how to reverse those transformations.
On the liability side of the Fed's balance sheet, QE swelled the stock of base money (the subset of the Fed's liabilities consisting of currency held by the nonbank public plus depository institutions' reserves) more than four-fold. Contrasting October 2015 to August 2008, the base rose to $4.06 trillion from $0.85 trillion. The mix of Fed liabilities shifted as approximately $2.6 trillion of the $3.2 trillion in new base money was added to the reserve balances of depository institutions (the other $0.6 trillion was added to currency held by the public). Total bank reserves have grown more than 50-fold, to $2.7 trillion from a mere $0.05 trillion. Only a tiny share of the added reserve holdings (about $0.1 trillion) are accounted for by the growth in required reserves accompanying growth in commercial bank deposits held by the public; the bulk are voluntarily held as excess reserves (balances over and above legally required reserves against deposits). Excess reserves have risen to $2.5 trillion and 62 percent of the monetary base, from only $0.002 trillion and close to zero percent (about two-tenths of 1 percent) pre-QE. (1)
While the QE programs accelerated the monetary base (hereafter MO) at an unprecedented rate, Figure 1 shows that they did not accelerate the quantity of money held by the public as measured by the standard broad-money aggregate M2 (currency in circulation plus all bank deposits). During the pre-QE decade of September 1998-September 2008, the Fed expanded M0 at a compound rate of 5.99 percent per annum. The expansion rate jumped to 23.69 percent per annum during September 2008-September 2015. The growth rate of M2 has fluctuated a bit but hardly changed over the longer term: 6.3 percent per annum in the pre-QE decade and 6.6 percent since the beginning of QE. The fact that M2 has hardly budged from its established long-term path indicates that quantitative easing was not a change in monetary policy, in the sense that it was not used to alter the path of the standard broad monetary aggregate in a sustained way. (2)
The growth rate of the M1 component of M2 (currency plus only checking deposits) did rise faster, to 11.5 percent per annum from 3.0 percent. But because M2 as a whole did not grow faster, this only indicates that households have reduced the share of their total bank deposits in savings (non-Ml) accounts and increased the share in checking accounts. This shift can be explained primarily by households responding to a collapse in the spread between savings and checking account interest rates, both rates hilling to near zero. The national average rate on three-month CDs, for example, tumbled to 16 basis points in September 2015 from...
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