Quantitative Easing

Quantitative easing is an unconventional monetary policy of buying financial assets in the market, which increases central bank reserves beyond the level needed to keep the short-term interest rates at zero. First used by the Bank of Japan in the early 2000s, it was adopted by the Fed and other major central banks (e.g. the Bank of England or the European Central Bank) after the global financial crisis of 2007-2008 in order to provide financial institutions with liquidity and lower the long-term interest rates (since the short-term rates were already at zero).

In the U.S., there were three rounds of the quantitative easing: QE1 from December 2008 to March 2010; QE2 from November 2010 to June 2011; and QE3 from September 2012 to October 2014. Contrary to QE1 and QE2, QE3 was an open-ended program without a stated end date. Initially, the program involved purchases of agency mortgage-backed securities at a pace of $40 billion per month, but was extended to purchases of Treasuries involving $45 billion per month.

In this largest asset-buying program, the Fed purchased assets worth around $1.6 trillion, expanding its balance sheet to about $4.5 trillion. The effectiveness of these asset-purchase programs is subject to debate. What is certain is that the quantitative easing programs expanded the Fed’s balance sheet and flooded commercial banks with reserves. The U.S. central bank’s balance sheet is now around $4.5 trillion, as opposed to the $800-900 billion range before the crisis (see the charts below).

Chart 1: Fed’s assets (in millions of dollars) from 2002 to 2014.

Chart 2: Fed’s balance sheet (blue line, right axis, in trillions of $) and the bank’s excessive reserves (green line, left scale, in trillions of dollars) from 2005 to 2015.

Quantitative Easing and Gold

The effects of quantitative easing on the gold market depended on how it was perceived by investors. Initially, after the financial crisis of 2008, quantitative easing was positive for the price of gold. It was a new and unprecedented program, which undermined the investors’ confidence and caused a fear of inflation or even hyperinflation. However, the U.S. economy recovered after some time and there was no inflation on the horizon. In consequence, the price of gold entered a decline in September 2011, just two months after the end of the QE2. As the confidence in the Fed and the U.S. economy was restored, the third round of the quantitative easing was welcomed by the investors. The increased confidence reduced risk premia and the bidding for tail risk insurance. Consequently, the stock market rose, while the price of gold declined.

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