Would Markets Plummet if Q.E. Program Ended Today?

On its third round of this unconventional monetary policy, the Federal Reserve is buying up securities in an effort to stabilize the economy post-recession. Years into the program, has quantitative easing become such a part of the economy that without it markets would plummet?

The quantitative easing program began after the collapse of Lehman Brothers in September 2008. Market capitalization made the steepest drop on record (for that time) the following month, and by November the Federal Reserve stepped in.

Described as a knee-jerk reaction, the Fed started buying up $600 billion mortgage-backed securities to add to its $800 billion on hand. By June 2010, the nation’s central bank had $2.1 trillion worth of securities, Treasury notes and bank debt in its coffers.

To maintain holdings while investment terms expired, the Fed began buying $30 billion Treasury bonds per month. After this initial propping up of the economy, the Fed announced round two of quantitative easing—another $600 billion buy up that lasted through spring 2011.

The third round, known as QE3, began in September 2012 at $40 billion in securities per month. Last December, the Fed increased those purchases to $85 billion. Moreover, the Fed announced it would keep the federal funds rate near zero at least through 2015.

Now, if markets trade on fundamentals, not the level of liquidity created by quantitative easing, as Wells Fargo Senior Economist Mark Vitner said in a recent article for the Long Beach Business Journal, then how might markets react if the Fed pulled the plug on the program?

Our economy functioned well before quantitative easing, Vitner said, so the markets should do just fine without it.

Just how well did the markets do when the Fed  announced in June that it would begin tapering quantitative easing? They freaked out. And what happened when the Fed announced in September it would continue quantitative easing? The S&P hit a record high.

These fluctuations are a reflection of the fact that tapering the monthly purchase of $85 billion in securities would likely push up interest rates not controlled by the Fed, hurting short-term investments made by people across the globe.

In an op-ed for the Wall Street Journal, former Fed official Andrew Huzar went as far as to apologize to the American public for helping institute quantitative easing.

Despite the Fed’s rhetoric, my program wasn’t helping to make credit any more accessible for the average American. The banks were only issuing fewer and fewer loans. More insidiously, whatever credit they were extending wasn’t getting much cheaper. QE may have been driving down the wholesale cost for banks to make loans, but Wall Street was pocketing most of the extra cash.

Despite the evidence that announcing the continuance or tapering quantitative has shifted markets he admits exists, Vitner said the Fed has learned to be more cautious this time around. Neil Irwin discusses the Fed’s approach to keep market tempers from flying here.

Janet Yellen, the nominee for the next chairman of the Federal Reserve Board is expected to follow Fed Chairman Ben Bernanke in his support of a plan to not begin winding down quantitative easing until the economy reaches specific marks in gross domestic product, unemployment and job growth.

Even so, the presidents of Dallas and Atlanta’s Federal Reserve banks support a timely and methodical wind-down, sooner rather than later. Richard Fisher, president of the Dallas Federal Reserve Bank, had this to say after a speech at Texas A&M University:

We should define a very clear path: that is, once we start tapering, absent some major disruption or thing that comes out of the blue, a definite path as to when we reach zero.

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