A wide range of market indicators supports the view that the Federal Reserve's securities purchases have been effective at easing financial conditions. For example, since August, when we announced our policy of reinvesting maturing securities and signaled we were considering more purchases, equity prices have risen significantly, volatility in the equity market has fallen, corporate bond spreads have narrowed, and inflation compensation as measured in the market for inflation-indexed securities has risen from low to more normal levels. Yields on 5- to 10-year Treasury securities initially declined markedly as markets priced in prospective Fed purchases; these yields subsequently rose, however, as investors became more optimistic about economic growth and as traders scaled back their expectations of future securities purchases. All of these developments are what one would expect to see when monetary policy becomes more accommodative, whether through conventional or less conventional means. Interestingly, these developments are also remarkably similar to those that occurred during the earlier episode of policy easing, notably in the months following our March 2009 announcement of a significant expansion in securities purchases. The fact that financial markets responded in very similar ways to each of these policy actions lends credence to the view that these actions had the expected effects on markets and are thereby providing significant support to job creation and the economy.

Is the program actually proving effective? My short answer is yes.

Conventional monetary policy works by changing market expectations for the future path of short-term interest rates, which, in turn, influences the current level of longer-term interest rates and other financial conditions. These changes in financial conditions then affect household and business spending. By contrast, securities purchases by the Federal Reserve put downward pressure directly on longer-term interest rates by reducing the stock of longer-term securities held by private investors. These actions affect private-sector spending through the same channels as conventional monetary policy.

I don't think that quantitative easing monetary policy is the reason that oil prices are up in the past few months. The dollar, after all, has been quite stable, and oil prices are up in essentially all currencies. I think the main reason oil prices are up is the strength of emerging markets, the demand for energy from China and other fast-growing, emerging market economies.

That being said, we're watching it very carefully because, as you point out, higher gas prices are like a tax on families. And if they get too high, then that will in fact be a negative for growth as well as for inflation. So we will pay very close attention to both energy prices and other commodity prices as well.

During the Q&A session

How does QE go about lowering long-term real interest rates? QE is a sufficiently novel monetary policy tool that different economists may well give different answers to this question. In my view, QE lowers long-term real interest rates in two distinct ways. The first is that QE is a form of nonverbal communication about the FOMC’s future plans... However, QE also lowers long-term real interest rates in a second, more direct, way. The holder of a long-term Treasury is exposed to interest rate risk, because the value of that bond fluctuates as interest rates vary. When the Fed buys $600 billion of long-term bonds, the bond portfolio of the private sector is now less exposed to this kind of risk. As a consequence, private investors will demand a lower premium for holding other bonds that are exposed to interest rate risk, and all long-term yields fall.

Although securities purchases are a different tool for conducting monetary policy than the more familiar approach of managing the overnight interest rate, the goals and transmission mechanisms are very similar...

Incidentally, in my view, the use of the term "quantitative easing" to refer to the Federal Reserve's policies is inappropriate. Quantitative easing typically refers to policies that seek to have effects by changing the quantity of bank reserves, a channel which seems relatively weak, at least in the U.S. context. In contrast, securities purchases work by affecting the yields on the acquired securities and, via substitution effects in investors' portfolios, on a wider range of assets.

Easing of monetary policy produces its maximum impact on real variables in the economy, including output, consumption, and investment, with a lag of six to 12 months and can be difficult to disentangle.

This sense out there, that quantitative easing or asset purchases, is some completely far removed, strange kind of thing and we have no idea what the hell is going to happen, and it's just an unanticipated, unpredictable policy—quite the contrary. This is just monetary policy.

As reported by the Wall Street Journal

This approach eased financial conditions in the past and, so far, looks to be effective again. Stock prices rose and long-term interest rates fell when investors began to anticipate the most recent action. Easier financial conditions will promote economic growth. For example, lower mortgage rates will make housing more affordable and allow more homeowners to refinance. Lower corporate bond rates will encourage investment. And higher stock prices will boost consumer wealth and help increase confidence, which can also spur spending. Increased spending will lead to higher incomes and profits that, in a virtuous circle, will further support economic expansion.

It doesn't make sense to do a small portion of QE... It has to be enough to make a difference. Something along the lines of $100 billion a month would be in range.

In fact, right now the economy and banking system are awash in liquidity with trillions of dollars lying idle or searching for places to be deployed or, perhaps more recently, going into inflation hedges. Dumping another trillion dollars into the system now will most likely mean they will follow the same path into excess reserves, or government securities, or “safe” asset purchases. The effect on equity prices is likely to be minor as well. There simply is no strong evidence the additional liquidity would be particularly effective in spurring new investment, accelerating consumption, or cushioning or accelerating the deleveraging that is hopefully winding down.

I think that the best empirical work on the question of how the LSAP affected long-term Treasury yields has been done by Gagnon, Raskin, Remache, and Sack (2010). Their paper is a thorough investigation of this key issue.  My conclusion from their work is that the LSAP reduced the term premium on 10-year Treasury bonds relative to 2-year Treasury bonds by about 40-80 basis points (on an annualized basis). (The term premium is a measure of the difference in yields that is not explained by the expected path of short-term interest rates.) This fall in term premia led to a slightly smaller fall in the term premia of corporate bonds.

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My own guess is that further uses of quantitative easing would have a more muted effect [than that of earlier action] on Treasury term premia. Financial markets are functioning much better in late 2010 than they were in early 2009. As a result, the relevant spreads are lower, and I suspect that it will be somewhat more challenging for the Fed to impact them.

I see QE as affecting the economy in four main ways. I’ll first discuss them from a theoretical perspective and then discuss what’s known about these effects empirically.

The first effect of QE is that it represents another form of forward guidance about the path of the fed funds rate. It is a way for the FOMC to signal—in a perhaps more striking way—that it plans to keep the fed funds rate low for an even longer time to come.

Second, QE creates more reserves in banks’ accounts with the Fed. The standard intuition is that this kind of reserve creation is inflationary... This basic logic isn’t valid in current circumstances, because reserves are paying interest equal to comparable market interest rates...

The third effect of QE is the one that is usually stressed: It reduces the exposure of the private sector to interest rate risk... All long-term yields fall, and so firms should be more willing to undertake long-term capital expansions or hire permanent employees.

The fourth effect of QE is less widely discussed. The Fed cannot literally eliminate the exposure of the economy to the risk of fluctuations in the real interest rate. It can only shift that risk among people in the economy. So, where did that risk go when the Fed bought the long-term bond? The answer is to taxpayers...

If action is taken by the Fed, a clear option is to grow the size of the balance sheet since the policy interest rate, for all practical purposes, cannot go any lower. Growth of the balance sheet would be accomplished by a second round of asset purchases (probably Treasury bills and notes) paid for by newly created money.

Policy actions should be commensurate with the risks that the economy faces. A series of smaller policy actions can add up to a large action, but only if incoming data suggest that as the appropriate course... Purchase size should be in proportion to the size of any deterioration in the outlook.