How the Federal Reserve`s Quantitative Easing Program Works Under the Monetary Transmission Mechanism

Kristoffer Rakneberg & Jørgen Stadheim Teigen

Student thesis: Master thesis


As the Federal Funds rate had hit the zero lower bound and with the objective to counter the contracting economy following the recent financial crisis, the Federal Reserve introduced unconventional monetary policies in the period from 2008 to 2014. As the zero lower bound had left the Federal Reserve`s conventional tools inoperable, the Federal Reserve sought to ease the overall financial conditions, by infusing credit markets with liquidity. Specific assets were targeted with the aim of reducing their yields thereby reducing borrowing costs for households and businesses. This paper examines how quantitative easing works under monetary policy transmission channels and further analyze the channels relevance in the US economy and their effect on asset prices. In doing so, an extensive report and review of the theoretical foundation that advocates for and against the existence of the transmission mechanisms of quantitative easing is conducted. The existing literature on the subject were assessed and summarized along with a report on the effects of the mechanisms and the response in asset prices. Movement in asset prices was assessed by examining day-to-day price changes and cumulative changes across the relevant time horizons. The review suggest that quantitative easing can successfully influence asset prices, at least under favorable conditions. The results imply that the effect can spread from the assets targeted by the Federal Reserve, to other assets which aids the reduction of real borrowing costs in financial markets. Further, this is consistent with the existence of a portfolio balance channel. We find that portfolio balance effects is likely to represent up to 70 percent of quantitative easing`s effect on Treasury yields. However, MBS purchases in QE1 and QE3 demonstrate that direct targeting of assets related to a specific sector is more effective than targeting US Treasuries. Due to financial stress during the QE programs, the bank-lending channel is found to be ineffective. As for the confidence channel, even in broad, relative terms, it is hard to access whether there has been a direct effect of QE on consumer and business confidence. Measures from investor confidence indicate that quantitative easing can affect stock prices. Our research supports that quantitative easing may provide the Federal Reserve with an effective tool at the zero lower bound

EducationsMSc in International Business, (Graduate Programme) Final Thesis
Publication date2015
Number of pages135