Unconventional asset purchase monetary policy is commonly known as quantitative easing. The Fed first adopted this policy during the 2008 financial crisis.
Normally, when a central bank wants to reduce the cost of borrowing for businesses and consumers, it lowers its target short-term interest rate. But with its target rate at zero during the 2008 crisis – when there was no inflation and the economy was still suffering – the Fed was no longer in a position to cut rates further. The Fed therefore turned to quantitative easing to further reduce borrowing costs. When the government buys assets, their prices go up, lowering their yield or interest rate.
The Fed adopted this policy again in March 2020 after the COVID-19 pandemic led to a nationwide lockdown. As of November 2021, the Fed had purchased more than US $ 4 trillion in treasury bills and other securities.
The U.S. central bank began to shrink in November 2021, reducing total purchases by $ 15 billion per month, from $ 120 billion to $ 105 billion. The Fed decided to double the pace of its decline on December 15. Instead of $ 15 billion, the Fed will cut its purchases by $ 30 billion each month. At this rate, it will no longer buy new assets by early 2022.
Why is this important
Growing concerns among economists that rising inflation could hurt the economy are likely a big part of what led the Fed to start cutting back gradually.
Inflation is the rate of change in the price of goods and services. The Consumer Price Index, which includes several categories of everyday items that a typical American might buy, is the most frequently reported measure of inflation in the media. In November 2021, it was up 6.8% from the previous year.
Regardless of the measure, inflation is above the Fed’s target of 2%. By cutting back on asset purchases, the Fed can help reduce inflation – or at least slow its rise – because it withdraws some of the monetary stimulus that fuel economic growth.
The reason the Fed decided to speed up the process is probably because it now believes inflation may be less transient than it had hoped, at the same time as the labor market looks strong.
What this means for you
Americans have enjoyed lowest interest rates for most of the past 13 years, which has made it cheaper to borrow money to buy cars and homes and start businesses.
Consumers and businesses are already starting to see slightly higher rates on mortgages, business loans, and other types of borrowing.
In other words, the era of cheap money may finally be coming to an end. Enjoy as it lasts.
Edouard Wemy is Assistant Professor of Economics at Clark University.