Quantitative Easing: Entrance and Exit Strategies

November/December 2010, 92(6), pp.465-79.easing is something aberrant.I adhere to that nomenclature here.I begin by sketching the conceptual basis for quantitative easing: why it might be appropriate and how it is supposed to work.I then turn to the Fed's entrance strategy-which is presumably in the past, and then to the Fed's exit strategywhich is still mostly in the future.Both strategies invite some brief comparisons with the Japanese experience between 2001 and 2006.Finally, I address some questions about central bank independence raised by quantitative easing before briefly wrapping up. THE CONCEPTUAL BASIS FOR QUANTITATIVE EASING: THE LIQUIDITY TRAPTo begin with the obvious, I think every student of monetary policy believes that the central bank's conventional policy instrument-the overnight interest rate (the "federal funds" rate in the United States)-is more powerful and reliable than quantitative easing.So why would any rational central banker ever resort to quantitative easing?The answer is pretty clear: Under A pparently, it can happen here.On December 16, 2008, the Federal Open Market Committee (FOMC), in an effort to fight what was shaping up to be the worst recession since 1937-38, reduced the federal funds rate to nearly zero. 1 From then on, with all its conventional ammunition spent, the Federal Reserve was squarely in the brave new world of quantitative easing.Chairman Ben Bernanke tried to call the Fed's new policies "credit easing," probably to differentiate them from actions taken by the Bank of Japan (BOJ) earlier in the decade, but the label did not stick.2 Roughly speaking, quantitative easing refers to changes in the composition and/or size of a central bank's balance sheet that are designed to ease liquidity and/or credit conditions.Presumably, reversing these policies constitutes "quantitative tightening," but nobody seems to use that terminology.The discussion refers instead to the bank's "exit strategy," indicating that quantitative 1 Specifically, the FOMC cut the funds rate to a range between zero and 25 basis points.In practice, funds have mostly traded around 10 to 15 basis points ever since.2 As will be clear later, the Fed's approach and the BoJ's approach were different.