QE and Asset Price Inflation

When the federal funds rate hit zero in December 2008, the Federal Reserve faced a novel problem: its primary policy instrument had reached its effective lower bound. Short-term rates could not go significantly negative without inducing banks to hold cash rather than deposits. Yet the economy was in free fall. The Fed's response was quantitative easing (QE): the large-scale purchase of financial assets -- initially mortgage-backed securities and longer-term Treasury bonds -- using newly created bank reserves. Between 2008 and 2014, the Fed's balance sheet expanded from roughly $900 billion to $4.5 trillion.

The economic rationale for QE was that purchasing long-duration assets would reduce long-term interest rates (by bidding up asset prices and reducing yields), stimulate lending, and support asset prices -- which would, through the "wealth effect," encourage spending by households and businesses that felt wealthier. The evidence on these transmission channels is mixed: long-term rates did decline, and there is some evidence of positive effects on bank lending and aggregate demand. But the magnitude of these effects relative to the unprecedented scale of asset purchases remains contested.

What is less contested is the distributional consequence. QE inflated asset prices -- stocks, bonds, and real estate -- substantially. Since financial assets are concentrated at the top of the wealth distribution (the wealthiest 10% of American households own approximately 87% of stocks), the benefits of asset price inflation accrued disproportionately to the wealthy. The Federal Reserve Bank of Boston estimated that QE increased the net worth of the wealthiest 20% of households by substantially more, in dollar terms, than the net worth gains of all other quintiles combined.

We have created a massive amount of liquidity. But the people who have benefited the most are the people who already had assets. That is uncomfortable for me. I don't think it's the major effect of our policies, but it's something we have to acknowledge.Richard Fisher, President, Federal Reserve Bank of Dallas, 2014

The chart below shows the Federal Reserve's balance sheet from 2000 through 2023. The pre-crisis baseline of under $1 trillion gives way to the QE-era expansion, the brief period of "quantitative tightening" (balance sheet reduction) attempted in 2018-2019, and then the massive further expansion in response to COVID-19, when the Fed's assets exceeded $8 trillion. Each expansion corresponded to a period of rising equity and real estate prices; each contraction or pause corresponded to market volatility.

The political economy of QE is worth examining directly. The policy that prevented a second Great Depression also transferred wealth toward those who already held the most of it. This is not an argument against QE -- the counterfactual of inaction is not attractive -- but it is an argument that monetary policy, even in emergency mode, has distributional consequences that deserve explicit acknowledgment and, potentially, offsetting fiscal policy designed to counteract them.