Quantitative easing, the program of asset buying initiated by the US Federal Reserve Bank in 2008, represents the most profound monetary experiment in the history of the world. Between fall of 2008 and fall of 2014, three successive rounds of QE quadrupled the monetary base of the world's most-used and dominant currency, from less than $1 trillion to more than $4 trillion. The Fed literally created new money, bought Treasury debt and mortgage-backed debt (of dubious character) from commercial banks, and credited them with new reserves.
It was a great trick. If QE can be done without adverse effects or with few adverse effects, it represents nothing short of monetary alchemy (h/t Nomi Prins). Everything we thought we knew about the Fed as backstop lender of last resort to commercial banks, as hallway monitor of inflation and unemployment, is out the window.
If QE works, then every government on earth must take notice of the opportunity to effectively recapitalize their own banks and industries free of charge. QE turns central banks into kings of capital markets, into active participants in the economy. As one twitterati put it, expansionary QE created the biggest untold American story of the last twenty years: the Fed can now inflate and deflate assets, devalue savings, influence wages and productivity, encourage corporate malfeasance, and engineer balance sheets—all the while creating economic winners and losers.
What politician or central banker could resist?
Recall how defenders of QE not only argued it was necessary, but beneficial. Paul Krugman was among the worst offenders, insisting that low interest rates would mitigate any harms from such rapid monetary expansion. These defenders dismissed, and continue to dismiss, what is now obvious: since 2008 the US economy has experienced significant asset inflation in equity markets and certain housing markets, plus a creeping but steady rise in many consumer prices.
This is no surprise. Did it never occur to QE cheerleaders that 1% money market yields might chase money into the stock market? Or that 2% interest rates might not encourage US businesses, households, and individuals to get solvent?
But monetary stimulus, like fiscal stimulus, is a heady drug for politicians and their central bank enablers. Once you accept consumption rather than production as the basis for a healthy economy, creating new money starts to sound like a good idea. And if creating money is a good idea, why not create a lot of it—especially in the midst of an economic crisis?