In response to a severe credit crunch driven by commercial property defaults and supply-chain bottlenecks, the Federal Reserve undertook emergency asset purchase programs. To avert a deep liquidity-driven contraction, the Fed implemented a targeted reinvestment scheme, purchasing $280 billion of agency mortgage-backed securities (MBS) and long-term Treasury bonds. This intervention aimed to maintain liquidity in the interbank lending market, suppress escalating mortgage rates, and prevent a deflationary spiral as consumer confidence plummeted.
By mid-2024, the macroeconomic landscape had evolved. Driven by resilient labor markets and persistent service-sector inflation, the Federal Reserve raised its benchmark federal funds rate to a target range of 5.25% to 5.50%. Yields on 10-year US Treasury notes spiked to 5.05%, reflecting heightened risk premiums and the absence of direct central bank yield caps. This surge in long-term yields threatened to choke off private sector capital investment.
The expansion of the Federal Reserve’s balance sheet through quantitative easing (QE) has drawn intense criticism. Some monetary economists argue that the massive expansion of bank reserves did not stimulate productive business lending but instead accumulated as excess liquidity within the financial system, fueling speculative bubbles in equities and residential real estate. This created a scenario where expansionary monetary policy exacerbated wealth inequality without driving real output growth.
Conversely, proponents of QE argue that aggressive asset purchases were vital to avoid a systemic financial freeze and a subsequent debt-deflation spiral. They contend that the expansion of the monetary base successfully anchored inflation expectations and prevented a catastrophic collapse in aggregate demand.
Additionally, escalating debt-servicing costs now limit the fiscal capacity of the federal government to fund critical public infrastructure projects, including a proposed $60 billion national high-speed rail and smart-grid modernization project intended to transition key industrial hubs to clean energy and boost long-term productivity.
With reference to Extract B, discuss the use of asset purchase programmes (quantitative easing) in preventing a deflationary recession.
