How the Federal Reserve’s Quantitative Easing Affects the Federal Budget
Report
In this report, CBO examines the mechanisms by which quantitative easing — large asset purchasing programs conducted by the Federal Reserve— affects the federal budget deficit.
Quantitative easing (QE) refers to the Federal Reserve’s purchases of large quantities of Treasury securities and mortgage-backed securities issued by government-sponsored enterprises and federal agencies to achieve its monetary policy objectives. Historically, the Federal Reserve has used QE when it has already lowered interest rates to near zero and additional monetary stimulus is needed. QE provides that additional stimulus by reducing long-term interest rates and increasing liquidity in financial markets.
QE affects the federal budget through two channels:
It changes net borrowing costs of the Treasury and the Federal Reserve.
It stimulates economic activity, which affects other budgetary categories.
If economic output was far below potential output (the maximum sustainable output of the economy) and short-term interest rates were set close to zero, the effects of QE would at first reduce federal deficits, generally. As economic conditions improved and interest rates rose, however, the deficit-reducing effects of that policy would diminish and could even reverse and add to the federal deficit.
In the Congressional Budget Office’s assessment, the Federal Reserve’s QE programs conducted in response to the 2007–2009 recession and the 2020 recession induced by the coronavirus pandemic initially reduced federal budget deficits. The QE programs also have led to earlier increases in the federal funds rate—the interest rate that financial institutions charge each other for overnight loans of their monetary reserves—than would have occurred otherwise, in CBO’s assessment. After the 2007–2009 recession, QE programs were followed by quantitative tightening (QT) policies—that is, reductions in the Federal Reserve’s holdings of Treasury securities and mortgage-backed securities.
In CBO’s projections, the Federal Reserve again conducts quantitative tightening from 2022 to 2025. Its holdings of Treasury securities gradually rise again in the later years of the decade to meet growing demand for currency. The net budgetary effects over time of the combined QE and QT policies are uncertain.
