Quantitative Easing and The Great Recession: Who Wins? Who Loses?

By Jerry Epstein

CPE Staff Economist


Fed Chair Janet Yellen

The Federal Reserve (Fed), the central bank of the United States, is at the center of a big political fight, once again. Ron Paul, former libertarian congressman, says we should “End the Fed” and reinstitute a gold standard; Rick Perry, former governor of Texas, said the Fed policy of low interest rates is “treasonous” and Fed officials should be sent to Texas where they know how to “deal with” such people; Senator Rand Paul (Ron’s son) has put forward a bill to “Audit the Fed” and establish more Congressional control over monetary policy; and progressives from Senators Bernie Sanders and Elizabeth Warren to the Occupy Movement are highly critical of the revolving door between Fed officials and Wall Street, but oppose Paul, Paul and Perry’s “hard money” policies that would make life harder for debtors.

This fight over monetary policy happens now and again in US history. In the Great Depression of the 1880’s the populist movement of indebted farmers rose up to demand a looser monetary standard that would make it easier for them to pay their debts; the financial panic of 1907 ushered in a 7 year struggle that culminated in the establishment of the Fed; and the great inflation of the 1970’s and the draconian increases in interest rates that Fed Chairman Paul Volcker engineered in the late 1970’s instigated widespread protests against the Fed.

Such enduring conflicts have real causes; in its founding and very structure, the Fed is a creature of the financial industry, yet the Fed has enormous economic power that affects everyone in the US economy (and indeed, the world) . Most importantly, it has enormous public power – to print legal tender (the US dollar)– yet it has a political structure that to varying degrees insulates it from democratic control. And with the demise of fiscal policy as a strong tool of macroeconomic policy (conservatives have blocked the use of government spending and taxation as tools of economic policy), the Fed’s power to set interest rates has become the most important and flexible tool of macroeconomic policy.

And now the crash of 2008 has led to the biggest fight in 75 years. We got into this fight because Alan Greenspan’s Fed failed to sufficiently regulate the banks that drove the economy into the ditch, and the Fed subsequently bailed out these same banks without punishing the guilty parties (we only know about this thanks to journalists and activists, the Fed has tried to block oversight). Central to the current fight is the battle over the Fed’s interest rate and monetary policy. Since late 2008, the Fed has undertaken a variety of unusual policies – it massively increased credit by buying a range of financial assets, and it has held short term interest rates close to zero in an unprecedented set of policies referred to as Quantitative Easing (QE). It was this policy that Rick Perry called “treasonous”.

And to be sure, there is a lot to be concerned about with the results of these policies. They have been accompanied by massive increases in the value of the “stock market”, record levels of profits of non-financial corporations, and the rebound of bonuses on Wall Street. By contrast, there have been much slower and limited gains for workers. The unemployment rate has been trending downwards, but wages have barely budged and many workers have given up looking for jobs. And yes: evidence indicates that virtually all the economic gains since the depths of the recession have been captured by the top 1%.

These inconvenient facts have created a paradox in our attempts to understand the relationship between monetary policy, worker’s well-being and inequality. Paul Volcker was roundly criticized in the 1980’s because his massive increases in interest rates threw workers out of work, raised profits for banks, and dramatically increased inequality. For decades the Fed has been criticized by progressives and heterodox economists for keeping interest rates too high, and for padding the profits of bankers while making it more difficult for businesses to invest, expand and create jobs. But now, the Fed is being accused of raising inequality by doing the opposite: by lowering interest rates.

Can both of these be true? Has the world been turned upside down? What can economic analysis tell us about who gains and who loses from the Fed’s recent Quantitative Easing (QE)?

A recent study by the IMF looked at the impact of Fed policy on income inequality in the US in the period between the Second World War and 2008, just prior to the recent financial crisis. (Innocent Bystanders: Monetary Policy and Inequality in the United States.) Their study supports the long-held view of progressives and heterodox economists: more restrictive monetary policy, which generates higher interest rates, leads to MORE inequality. It helps the wealthy and the “creditors” who lend money by raising interest rates and raising the returns on their wealth, keeps inflation in check so it preserves the value of their wealth, and hurts workers by slowing job creation and harming debtors by raising the interest rates they have to pay.

Has there been a change since 2008? Recent research by Juan Montecino, a UMass graduate student, and myself has identified some clear winners from the Fed’s QE policy. We found that the initial round of QE in 2009 did increase bank profits, especially among those large banks that held large quantities of toxic financial assets (Juan Antonio Montecino and Gerald Epstein, “Have Large Scale Asset Purchases Increased Bank Profits” ). But we found little evidence that these policies increased lending to businesses. In a related study (“The Political Economy of Quantitative Easing: Who Stood to Gain?”), Montecino and I studied the impact of the full period of QE on the expected profits of all sectors of the US economy. We found once again that the large financial firms stood to gain from the policy; these were joined by companies in construction and autos. But the expected benefits from these policies faded for most sectors by the last round of QE in 2012-2013. This might explain why the Fed abandoned the policy soon thereafter.

So we have clear evidence that the big banks gained from the policy. But the impacts on wages and employment for the bulk of the population have been much more muted. Does this mean that a better policy would be to do as Paul, Paul and Perry propose? Doubtful. High interest rates and an inflexible monetary standard such as the “gold standard” would only bring us back to the days of costly credit, slow job growth, and new ways for lightly regulated Wall Street banks to crash the economy again.

But at the same time, it is clear that current monetary and macro policy more generally is not working well for the bulk of the population. Until it does, political pressure will keep focusing on the Federal Reserve, as it should. But don’t forget the Wall Street banks and corporations that stand to gain from the Fed’s policies, and the missing-in-action fiscal policy that places way too much pressure and responsibility on the Fed.