Can QE save economies this time?

QE now functions like a “narcotic,” requiring ever-larger and riskier interventions, with diminishing benefits for the real economy.

Quantitative easing (QE) was highly effective in 2008 because long-term Treasury yields could still fall, transmitting stimulus through refinancing and lower borrowing costs. By 2020, however, long-term risk-free rates had already dropped to near zero, leaving QE with little room to lower safe yields.

A return from QE becomes less likely as the credit risk relentlessly piles up.

To sustain stimulus, central banks expanded QE into riskier assets like corporate bonds and ETFs. This shift inflated asset prices rather than real spending, created financial fragility, and exposed taxpayers to greater credit risk.

The Evolution and Limits of Quantitative Easing

Nowadays, central bank policies have grown complex—even for professional economists. The hero of the last global financial crisis, quantitative easing (QE), has returned to the spotlight. But this time, the dose is higher, extending to riskier assets such as corporate bonds and exchange-traded funds (ETFs).

The funding rate—or policy interest rate—remains the primary monetary policy tool. During recessions, lowering nominal interest rates reduces the real interest rate, assuming inflation expectations remain stable. A lower real interest rate incentivizes consumers to bring forward spending because delaying purchases yields little benefit (Woodford, 2003).

However, interest rate policy has a lower bound. Nominal interest rates cannot fall much below zero due to cash hoarding and banking system frictions (Brunnermeier & Koby, 2018). When policy rates reach this zero lower bound (ZLB), central banks turn to unconventional tools like QE and forward guidance to stimulate demand.

QE in 2008: Room to Maneuver

During the 2008 Global Financial Crisis, QE was highly effective because long-term Treasury yields still had room to fall.

• In 2008, the 10-year U.S. Treasury yield was around 3.7% (FRED, 2024).

• The Federal Reserve’s purchases of long-term treasuries and mortgage-backed securities (MBS) successfully drove yields closer to 0–1%, stimulating refinancing, lowering borrowing costs, and supporting the housing market (Gagnon et al., 2011).

• QE operated through the portfolio rebalancing channel: as investors sold Treasuries to the Fed, they shifted into slightly riskier assets, gradually transmitting stimulus to the real economy.

This environment allowed QE to be a “clean” monetary stimulus, mostly limited to risk-free assets, with limited taxpayer exposure.

QE in 2020: Risk-Free Rates Hit Zero

By the COVID-19 recession, the environment had changed drastically:

• The 10-year Treasury yield fell below 1% by March 2020, touching 0.52% in August 2020, a record low (U.S. Treasury, 2020).

• Long-term risk-free rates had effectively hit zero, leaving no room for QE to lower safe yields further.

With risk-free yields exhausted, central banks expanded QE to riskier assets—corporate bonds, ETFs, and in some countries, even equities (Bank of Japan).

This shift changed QE’s risk profile and effectiveness:

1. Businesses did not increase real investment, as recessions suppress revenue expectations.

2. Cheap credit fueled financial engineering, like share buybacks or balance sheet repair, rather than household consumption.

3. Asset prices inflated rapidly, decoupling from real economic recovery—illustrated by the S&P 500’s 67% rise between March 2020 and August 2021, despite weak GDP growth (FRED, 2024).

The QE “Narcotic” and Financial Fragility

As the Fed absorbs riskier assets, financial markets produce even riskier instruments to meet investor demand for yield. QE increasingly fuels asset price bubbles instead of goods and services inflation. Each new round requires higher doses and riskier purchases, resembling a narcotic addiction (Borio & Zabai, 2016).

• Credit spreads temporarily narrow, but the underlying credit risk accumulates.

• Financial fragility grows, as market corrections trigger larger systemic stress.

• Taxpayers implicitly bear greater bailout risk when central banks hold risk-laden portfolios.

In short, QE’s effectiveness diminishes as the policy frontier moves from safe to risky assets, while its costs and risks to financial stability rise.

Conclusion

QE was an effective crisis tool in 2008, when long-term Treasury yields could still be pushed toward zero, stimulating credit, refinancing, and real demand. By 2020, risk-free rates had already collapsed, forcing QE into riskier assets with diminishing returns and rising systemic risks. Without complementary tools—such as direct income transfers or leverage-based credit policies—QE risks fueling asset bubbles rather than real recovery.

References

• Borio, C., & Zabai, A. (2016). Unconventional monetary policies: A re-appraisal. BIS Working Papers 570.

• Brunnermeier, M. K., & Koby, Y. (2018). The reversal interest rate. NBER Working Paper 25406.

• Federal Reserve Economic Data (FRED). (2024). 10-Year Treasury Constant Maturity Rate. Federal Reserve Bank of St. Louis.

• Gagnon, J., Raskin, M., Remache, J., & Sack, B. (2011). The financial market effects of the Federal Reserve’s large-scale asset purchases. International Journal of Central Banking, 7(1), 3–43.

• U.S. Treasury. (2020). Daily Treasury Yield Curve Rates.