The Federal Reserve is ending its policy known as quantitative easing by tapering its bond purchases and the buildup of idle bank reserves. This is already helping bank lending. The prospect of a further gradual normalization of Fed policy should lift economic growth above its devastating “new normal”–the slow GDP growth and high unemployment that have prevailed since 2008.
The conventional view was that the Fed could be stimulative by buying bonds, setting interest rates near zero and adding massive bank reserves. Financial markets advertised the policy as “easy money,” but none of the channels worked. Instead, growth in GDP, wages, jobs, credit, the M2 money supply, bank lending and bank deposits were all notably weak, causing a grinding multiyear decline in middle-class living standards.
The Fed’s stated goal with QE was to lower long-term interest rates, not increase credit or bank lending. Since the 2008 economic crisis the regulatory goal has been to reduce bank leverage and risk, restraining growth in total credit, even as the Fed guided more credit to upscale bond and securitization markets.
Well-established long-term borrowers that didn’t need help got more credit while riskier new borrowers saw less credit and created fewer jobs. The end result was contractionary.
The Fed began winding down its QE program on Jan. 1, sparking a surge in commercial and industrial lending. This type of bank lending is a critical, traditional source of credit for small businesses and startups. Growth was weak in 2009-13 but jumped to a 16% annual rate in the first quarter, when the taper started.
The 2014 change in the Fed’s direction is dramatic and should help growth.