When I was taking an advanced macroeconomics course at the University of Michigan in 2007, Miles Kimball, my professor — and later my doctoral advisor — explained to the class how to fight a recession. “Print money and buy stuff,” he exclaimed. Then, for good measure, he repeated the phrase three more times.
“Stuff,” in this case, meant financial assets. Kimball subscribed (and still subscribes) to the idea that macroeconomic management is all about money. When times are tough, investment is low and unemployment is high, the government — i.e., the central bank — should create money and exchange it for financial assets. If buying government bonds doesn’t do the trick, the bank can buy all sorts of other things — housing-backed bonds, stocks, even houses themselves — until the economy sputters back to life.
This idea is sometimes called monetarism, though it’s also associated with a school of thought called New Keynesianism. The idea that exchanging money for financial assets can overcome a downturn was enthusiastically promoted by Milton Friedman, the great prophet of monetarism. When Japan was in a prolonged slump in the 1990s, Friedman advocated just such a large-scale asset-purchase program:
The [Japanese] economy went into a recession. … Monetary growth has been too low. Now, the Bank of Japan’s argument is, “Oh well, we’ve got the interest rate down to zero; what more can we do?”
It’s very simple. They can buy long-term government securities, and they can keep buying them and providing high-powered money until the high powered money starts getting the economy in an expansion.
Thus was born the idea of quantitative easing, or QE for short. Japan used the policy in the 2000s, and much of the developed world adopted it during the Great Recession in 2009 and beyond. It was the great triumph of monetarist influence, though Friedman didn’t live to see it.
Now the Federal Reserve is officially ending that policy (though some would say it unofficially ended a year ago). Federal Reserve Chair Janet Yellen has said that the bank will begin divesting itself of the huge pile of financial assets that it bought during the last decade. Though QE continues in Japan and Europe, the great monetarist experiment is over — at least for now — in the home of the economists who conceived of it.
What have we learned from that experiment? The answer will be important for future policy makers. Put simply, did QE work?
Like all macroeconomic questions, this is a hard one to answer. We don’t really know how fast the economy would have grown in the absence of QE. Some people, such as former Fed Chairman Ben Bernanke, think the effect was large. And it’s true that the Great Recession in the U.S. didn’t end up being anywhere nearly as severe as the Great Depression of the 1930s. But that could be due to other reasons — many fewer bank failures, more government stimulus spending or simply a more robust modern economy. It’s also true that the U.S. recovered faster from the shock than Europe did — but again, that might be due to differences in fiscal policy, or to different initial conditions.