POLICY BRIEF
18-19 QE: A User’s
Guide
Joseph E. Gagnon and Brian Sack
October 2018
Joseph E. Gagnon is senior fellow at the Peterson Institutefor International Economics. Brian Sack is director of global
economics at the D. E. Shaw group.
Authors’ Note: We thank Chris Collins for assistance with thedata and Ben Bernanke, Bill English, Patrick Honohan, Michael
Kiley, Don Kohn, and Ángel Ubide for helpful comments. All
views expressed in this Policy Brief, and any errors, are thoseof the authors and do not represent the views of the Peterson
Institute for International Economics or the D. E. Shaw group.
© Peterson Institute for International Economics.
All rights reserved.

In recent years several major central banks have conductedlarge-scale purchases of long-term bonds and other financial
assets to stimulate economic growth, boost employment, andraise inflation towards its targeted level. These policies havecome to be known as quantitative easing (QE). Central banks
turned to QE when they believed that further reductions intheir conventional short-term policy interest rates were either
not possible or not helpful. With interest rates expected toremain at historically low levels around the world, it is likelythat central banks will have to turn to QE again the next timea recession strikes.
Even though QE has assumed a prominent role as apolicy instrument for central banks, the implementation of
QE has differed significantly both across countries and overtime. This variation is perhaps not surprising for a policy
instrument that was novel. However, despite the prominentrole played by QE over this period, surprisingly little discussion exists among policymakers or academic researchers on
what type of approach for QE is the most appropriate.
This Policy Brief aims to fill in that gap. It draws on theliterature measuring the effects of QE as well as the historicalexperience in implementing QE to lay out a simple strategy
for how to use QE. It makes a proposal that arguably tran-

sitions most effectively from the interest rate adjustment
process that central banks have employed with their primarypolicy instrument and shares many of the desirable propertiesof traditional monetary policy.
In particular, this Brief proposes that central banks
should characterize QE in terms of the stock of long-term
asset holdings and should announce purchases of assets in discrete increments that are designed to deliver macroeconomic
stimulus equivalent to the policy rate cut that they would otherwise desire to implement. For the United States and someother countries, research suggests that a purchase of long-termbonds equivalent to 1.5 percent of GDP has a stimulative
effect roughly equal to a cut in the policy rate of 0.25 percentage point. The vast majority of policy moves historically havebeen around 0.25 and 0.50 percentage point, and hence thetypical size of asset purchase announcements under this rulewould be either 1.5 or 3.0 percent of GDP.
Moreover, central banks should convey that these adjustments will be made under a policy approach that responds
routinely to economic developments and displays considerable inertia, as has typically been the case with the conventional policy interest rate. As a result, market participants
could expect an announcement of asset purchases in the recommended range to be followed by additional policy steps,
with those additional steps depending critically on how theeconomy evolves.
This proposal is more consistent with the traditional
policy framework of central banks than is the case for mostQE programs that have been implemented, as those programs
have tended to either (1) announce a much larger amountof purchases all at once or (2) announce a much smaller
amount of purchases that continue indefinitely on a monthly
flow basis. The analysis here compares these approaches anddiscusses their relative merits.
REVIEW OF QE IN THE UNITED STATESThe Federal Reserve used QE as a way to achieve more
accommodative financial conditions over the period during
and after the global financial crisis that began in 2008. QE
can reduce bond yields both because it may signal that thepolicy interest rate is likely to remain near zero for a longtime and because it reduces the supply of longer-term bonds
for private investors. The latter effect, known as the portfolio

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PB 18-19

October 2018balance effect, operates by reducing the aggregate amount of
duration risk held by private investors, which in turn should
push down the term premium in bond yields.1 The analysis
in this paper focuses on how to structure asset purchases
assuming that the portfolio balance channel is the primarymanner in which asset purchases affect the economy.2
The Federal Reserve implemented QE through four
separate programs over the period from late 2008 until 2014.
As described next, there were significant differences acrossthe QE programs.

The initial announcement in November was aimed inlarge part at addressing stresses in the US mortgage market
and at improving market functioning. However, the extension of the program in March was clearly aimed at providing
monetary stimulus to the economy.5 At the March 2009
meeting, Fed staff presented economic model simulations
showing that the optimal path of monetary policy, if unconstrained by the zero bound, would have taken the federal
funds rate to around –6 percent. By announcing the $1.75
trillion asset purchase program, now commonly referred to as
QE1, the Fed intended to replicate the effects of a significant
reduction in the federal funds rate.6
Notably, this policy decision was made as if it were a onetime policy action, in that the entirety of the program wasannounced in March 2009, even though it was expected totake until December 2009 to complete all of the purchases.7
This approach of announcing the full extent of the program
upfront is remarkable, given the amount of stimulus that the
FOMC was trying to provide and the uncertainty about theeffects of asset purchases.8 Indeed, based on the staff analysis
just mentioned, these actions were much larger than any
other single policy step taken throughout the crisis.

QE1

The Federal Reserve Board first announced large-scale purchases of longer-term assets in November 2008 and indicatedits intention to buy $600 billion of agency bonds and agency
mortgage-backed securities (MBS). At their next meetingin December 2008, the Federal Open Market Committee(FOMC) released a statement that took the federal funds rate
target down to its effective lower bound of 0 to 0.25 percent.3 In March 2009, the Fed expanded the asset purchaseprogram to “up to” $1.75 trillion, including purchases of$1.25 trillion of MBS, $200 billion of agency debt, and $300
billion of Treasuries. Total QE1 purchases were equivalent to12 percent of GDP.4

QE2

With the benefit of hindsight, it is now clear that QE1
was not sufficient to generate a robust economic recovery.
Indeed, employment and GDP growth over the subsequent
years would repeatedly turn out softer than expected, leading

1. Duration risk refers to the uncertain fluctuations in asecurity’s value that are created by changing market rates of
discount applied on future coupon and principal payments.
A security’s duration is the average waiting time until future
coupons and principal are paid weighted by the amounts ofeach future payment.

$1,150 billion in March is divided by 2009 GDP, and the total
is the sum of these two percentages.

2. Because the QE proposal in this paper (detailed in
the next section) retains the considerable inertia alreadyinherent in conventional policy approaches, a decision topurchase long-term assets likely would be followed by additional purchases and would signal that the policy interest
rate is likely to remain near zero for a long time. The signal
from QE about future policy rates under this proposal would
therefore be similar to the signal in a conventional reductionof the policy rate.

5. From the beginning, the Fed stressed the effects of its
purchases on the asset prices in the markets in which it
made purchases and the spillover effects to related markets.
It did not stress the liability side of its balance sheet andthe effects on various monetary aggregates, as it generally
believed that those effects were unimportant.
6. The staff Bluebook prepared for the March 2009 meetingsuggested that $1 trillion of additional purchases of longerterm Treasury and MBS (implying total purchases of $1.6
trillion, close to the amounts implemented in QE1) might
move the employment and inflation paths roughly one-thirdof the way toward the optimal path associated with a federal
funds rate of –6 percent (Board of Governors of the Federal
Reserve System, Bluebook, March 17–18, 2009, https://www.
federalreserve.gov/monetarypolicy/fomchistorical2009.
htm). Later studies led to some downward revision of theestimated effects, suggesting that QE1 may have beenequivalent to cutting the federal funds rate by 1 percent(Engen, Laubach, and Reifschneider 2015).

3. The FOMC includes all members of the Federal Reserve
Board plus 5 of the 12 presidents of the regional Federal
Reserve Banks on a rotating basis. All 12 presidents participate in FOMC meetings, though only 5 are voting members
at any time. The FOMC normally decides on open market
operations and the federal funds rate target, whereas theFederal Reserve Board determines the interest rates paidon bank reserves and charged on Fed loans to banks. The
Board’s November 2008 decision to buy agency-related
securities technically impinged on the prerogative of the
FOMC, but it received retroactive approval from the FOMC.
Subsequent asset purchases were decided by the FOMC.
The term “Fed” is used here loosely to refer to the Board, the
FOMC, and the Reserve Banks.

7. Later in 2009, the pace of purchases was slowed gradually
so that the program ended in March 2010.

4. QE purchases are expressed as a percent of the annual
GDP in the year they were announced. For QE1, the $600
billion in November is divided by 2008 GDP, the additional

8. In light of the uncertainties involved, the FOMC left open
the possibility of curtailing the program before reaching thestated maximum purchases.

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QE3

the FOMC to implement a series of additional asset purchaseprograms.
In November 2010, the Fed announced the first of thoseadditional steps, which involved purchases of $600 billion of
long-term Treasury securities, to be completed by June 2011.

QE3 began even before the MEP was completed. In September 2012, the Fed decided to start purchases of MBS of$40 billion per month with no set end date. In December
2012, the Fed decided to continue Treasury purchases at the
MEP rate of $45 billion per month indefinitely and to stop
selling off shorter-term Treasury securities. Total monthly
purchases were thus $85 billion, or 0.5 percent of GDP.
The program continued at that pace until December 2013,
when the Fed decided to slow the pace of purchases to $35
billion in MBS and $40 billion in longer-term Treasuries permonth. These purchase rates were then gradually reduced
over subsequent months until they ceased in October 2014.
In total, the Fed bought $1.5 trillion of Treasury debt andMBS under QE3, or 9 percent of GDP.10
The notable difference between QE3 and earlier asset
purchase programs was that it was a flow-based program.
That is, it specified a monthly flow of purchases rather thanan overall stock of purchases for the program. Prior to thelaunch of QE3, Fed staff prepared a memo with resultsfrom economic model simulations showing that the stockand flow-based approaches have identical effects on theeconomy when they both culminate in equal volumes of asset
purchases and financial markets correctly anticipate such
equal purchases. This result reflects the fact that, in the Fed’smodel, QE operates through the expected stock of Fed asset
holdings. The primary argument in favor of the flow-based
approach is that it may make it easier to communicate about
the Fed’s policy reaction function—an issue discussed in thenext section.

The Federal Reserve used QE as away to achieve more accommodative
financial conditions over theperiod during and after the global
financial crisis that began in 2008.
At 4 percent of GDP, this program was obviously smaller
than the first asset purchase program. One important aspectof QE2 was that it made clear that the FOMC would use
asset purchases in an ongoing manner to achieve macroeconomic objectives.9
Maturity Extension Program

The third program implemented by the Fed was the Maturity Extension Program (MEP), which was announced
in September 2011. Under this program, the Fed initiallydecided to purchase $400 billion in Treasury securities withmaturities greater than six years and sell an equal amount of
securities with maturities less than three years, with implementation taking place over a period of nine months. In
June 2012, the Fed extended the program through the endof 2012, which meant that the program ultimately removed$667 billion of long-term securities from the market, equivalent to 4 percent of GDP.
The MEP was similar to the earlier QE programs inthat its primary focus was on the net amount of duration
risk removed from the market. However, it had the twist ofaccompanying asset purchases with sales of securities of equalpar value. The Fed added this feature primarily to allay any
concerns, whether within the FOMC or external, about afurther expansion of the Fed’s balance sheet, even though
the sale of short-term securities was expected to have little
impact. This feature created an unnecessary restriction that
limited the scope of this program.

A PROPOSED APPROACH FOR QE

The reason that central banks have turned to asset purchases
has been that their primary policy instrument, the short-term
interest rate, was constrained by the zero lower bound.11
Given that asset purchases substituted for cuts in the policyrate, it would make sense for the policy rule governing asset
purchases to be similar in nature to the policy rule that
describes the policy rate. However, that has not been the caseso far in the United States.
10. For QE3 and other flow-based programs, the monthly
purchases within each year are summed up and divided
by that year’s GDP. Totals are arrived at by adding up thepercentages of GDP over the life of the program.

9. Many observers at that time still considered QE1 to havebeen aimed strictly at market functioning. For these observers, the initiation of QE2 was seen as a considerable shift inthe behavior of the Fed, prompting a strong critical reaction
from economists, politicians, and foreign policymakers—raising concerns about inflation, risky investments, and net capital outflows that never materialized. Of course, the view that
QE1 was entirely focused on market functioning is incorrect,
as indicated in the FOMC materials that have been released
for that period.

11. In a few countries, short-term policy interest rates havebeen pushed slightly below zero, but it appears that thelower bound is not far below zero. When the European
Central Bank (ECB) announced its QE program in January
2015, the accompanying statement said that “key ECB
interest rates have reached their lower bound.” At that time,the deposit facility rate was –0.4 percent, where it remains
today. Switzerland has the lowest rate, at –0.75 percent.

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To determine a policy rule that is “similar in nature”
requires specifying the nature of QE effects and comparing them to the effects from the federal funds rate. Most
researchers have settled on the stock theory of QE effects—
that the effects on long-term interest rates and the economy
are proportional to the stock of long-term bonds held by thecentral bank. In that regard, the size of the Fed’s long-term
asset holdings may be viewed as analogous to the level of thefederal funds rate.12 Moreover, just as expectations of thefederal funds rate affect financial conditions, it is generally
assumed that the expected future asset holdings of the central
bank drive financial conditions.
To be sure, no mapping between the central bank’s
asset holdings and the use of its policy instrument is perfect.
However, as noted above, even from the early days of QE1,
the Fed staff calibrated the effects in this manner; the size of
the QE1 program was set to replicate the effects of moving
the federal funds rate to a substantially negative level. And
that type of comparison was repeated in much of the staff
analysis of QE programs over the subsequent years.
The research literature has extensively studied the effectsof QE,13 and the most plausible empirical estimates suggestthat around $300 billion of purchases (1.5 percent of GDP)should have an effect that is roughly equivalent to a 0.25
percentage point cut in the policy rate.14 This mapping isbased on the composition of assets purchased in QE3, which
had a somewhat longer duration than the composition of
QE1 and QE2. It is also based on an assumption that market
participants expect the assets will be retained on the Fed’sbalance sheet for many years. If assets are expected to be
sold or allowed to run off relatively quickly, QE’s potency iscorrespondingly reduced. Keeping these points in mind, thismapping is used here as a rough guide.
For the federal funds rate, the FOMC is generally seen as
following an inertial policy rule that determines the intended
level of the policy rate, typically moving in steps of 0.25
percentage point. If the mapping discussed above is applied
to this policy rule, it suggests a particular approach for how
the Fed should adjust the balance sheet, which is the basis of
the proposal in this Brief.
Specifically, QE should be implemented through anapproach that focuses on the stock of long-term asset holdings, adjusts that stock of holdings in increments of $300
billion (1.5 percent of GDP), and demonstrates considerable
inertia—so that market participants would likely expect the
Fed to follow an increase in asset holdings with additional
adjustments in the same direction.15
This approach most closely replicates the manner inwhich the FOMC sets its primary policy instrument, providing many of the same benefits offered by that approach.
It is operationally feasible as $300 billion of QE could bepurchased in three months or less (within the span of two
FOMC meetings, which is the frequency at which the FOMC
has been acting recently) with little difficulty.16 Moreover, as

12. The balance sheet measure would ideally be based on therisk attributes of the assets held rather than the overall sizeof those holdings. For example, if removing aggregate duration risk is the primary channel through which QE operates,
then it would make sense to use a measure such as “10-year
equivalents,” which is the aggregate amount of duration
risk expressed in terms of the amount of 10-year notes thatare needed to replicate that risk. However, the focus on
the overall size of long-term securities holdings is retained
here for simplicity of communication. The term “long-term”
is used to capture any assets with a meaningful amount of
duration risk.

(2017) refers to “the conventional rule of thumb” that a 0.10
percentage point reduction in the 10-year yield is equivalent
to a 0.25 percentage point cut in the federal funds rate,
which is consistent with the midpoint of the range in Laforte
and Roberts. Thus, each $100 billion in purchases would
be equivalent to a cut of 0.10 percentage point. However,
GDP in 2018 is roughly 20 percent larger than GDP in 2013,
suggesting a somewhat larger amount of purchases would
be needed to achieve the same results as five years ago. The
analysis here follows previous studies in scaling by GDP, butother normalizations are possible, such as scaling by the sizeof the bond market.

13. Gagnon (2016) reviews research on the effects of QE in
the United States, United Kingdom, euro area, Japan, andSweden. Gagnon (2018) refutes the claim that QE works only
during times of market stress.
14. Fed staff estimate that $1.5 trillion of asset purchases under QE3 reduced the 10-year term premium 0.60 percentage
point in late 2013 (Engen, Laubach, and Reifschneider 2015).
Comparing the economic effects of such a program withthose of a cut in the federal funds rate depends on manyfactors, including assumptions about the monetary policy
rule in the future, how markets form expectations concerning
future policy, and how one weighs different implications for
output and inflation. Roughly speaking, a 0.60 percentage
point reduction in the 10-year yield would be equivalent toa cut in the federal funds rate of 1 to 2 percent (Laforte andRoberts 2014). Kiley (2014) raises some theoretical reasonsthat empirical models may overestimate the macroeconomic
effects of yield changes driven by the term premium as
opposed to the expected path of future short rates, but
the magnitude of this discrepancy is uncertain. Bernanke

15. Others have explored the benefits of applying policy rules
to asset purchases. Kiley (2018), for example, showed thatrules for long-term asset purchases based on the state of theeconomy can be helpful in alleviating excess unemployment
and low inflation caused by the lower bound on the policy interest rate. In addition, the Fed staff studied a policy rule approach in an October 2011 memo and found that it performs
well in response to various shocks (Dave Reifschneider, John
Roberts, and Jae Sim, “Incremental Balance Sheet Policies,”
October 24, 2011, Board of Governors of the Federal Reserve
System, https://www.federalreserve.gov/monetarypolicy/
files/FOMC20111024memo01.pdf).
16. In a speech in March 2013, the head of the Markets Groupat the New York Fed, Simon Potter, made the following observation about the $85 billion per month pace of purchases:

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the economic effects of purchases largely begin with their announcement rather than their implementation, a temporary
backlog of purchases underway is not a serious problem.
When it is time to tighten monetary policy after the startof QE purchases, there are grounds to support the current Fed
practice of first starting to raise the federal funds rate above its
lower bound and allowing asset holdings to run off gradually
only after the funds rate is significantly above zero. The Fed
always retains the option of outright sales of QE assets, butrate—an unusually large policy step to be announced at asingle point in time.17
This observation brings us to the key point. As noted
above, QE1 was calibrated as if it were a one-time opportunity to expand the balance sheet. The program was not calibrated as if QE were an instrument to be regularly updated
and sized under a policy rule with inertia. Under that typeof rule, even if the FOMC felt that it would ultimately want
to do the equivalent of 1.25 percentage points of easing, it
would typically implement that move in a sequence of smaller
policy steps in the same direction, allowing it to observe theeconomy on the way and make adjustments as needed. If the
FOMC knows that it will be assessing QE holdings regularly,
then it should determine the optimal size of its policy actions,
keeping that in mind and allowing for future continuationsof policy steps as needed.18
By adjusting QE holdings in more conventionally sized
steps and making regular policy decisions at every meeting,
the Fed would provide the markets with a considerable
amount of information about its reaction function. The
market could assess the monetary policy rule in the same waythat it does for movements in the federal funds rate, seeing
how those decisions are affected by changing economic
conditions. To further boost the market’s understanding of
its policy approach, the FOMC should include projectionsof the Fed’s long-term asset holdings alongside projections of
the federal funds rate in its quarterly summary of economic
projections.19
Comments on whether a large, one-time QE announcement is appropriate have been sparse. In a paper focused onchanges to the Fed’s inflation target to reduce the macroeconomic constraints imposed by the lower bound on interest rates, former Fed chair Ben Bernanke (2017) made thefollowing observation on the future use of QE: “Moreover,because some significant part of its power comes throughsignaling effects, QE is also a difficult tool to use in a con-

Given that asset purchases
substituted for cuts in the policy rate,
it would make sense for the policy
rule governing asset purchases tobe similar in nature to the policy
rule that describes the policy rate.
in most circumstances tightening by the federal funds rate is
likely to be preferred. The primary reason is that there is noconstraint on raising the federal funds rate, and policymakers
would prefer to rely on the traditional instrument if possible,
given their greater familiarity with it. Another importantreason for allowing only gradual run-off of QE assets is tomaintain a precedent that such assets remain on the balance
sheet for a long time after purchase. This precedent helps toboost the potency of QE to the extent that market participants respond not only to the current supply of longer-term
assets but also to the expected future supply.
Comparison to large, one-time programs

This proposed policy approach for QE would have the Fed
move in smaller steps than QE1, QE2, or the MEP undermost circumstances. For example, the expansion of QE1
from $600 billion to $1.75 trillion in March 2009 was theequivalent of a 1.25 percentage point cut in the federal funds

17. Here the mapping is adjusted to be consistent with thelower level of GDP in 2009 and rounded to the nearest 0.25
percentage point. As discussed above, the average durationof QE1 purchases was lower than that of QE3, so that thismove may have been equivalent to a 1 percentage point cut.
On the other hand, the Fed staff’s initial estimates suggested
the move would be equivalent to a 2 percentage point cut.

“So far, there seems to be little evidence that the current
pace of purchases is straining the market’s ability to deliver
securities to us” (Simon Potter, “The Implementation of
Current Asset Purchases,” remarks at the Forecasters Clubof New York, New York City, Federal Reserve Bank of New
York, March 27, 2013, https://www.newyorkfed.org/newsevents/speeches/2013/pot130327). A memo by Fed staff in
October 2011 estimated that monthly purchases of longerterm Treasury securities and MBS as high as $140 billion permonth, on top of purchases needed to replace securities
running off, might be possible without significant adverse
effects on market functioning (Reifschneider, Roberts, andSim, “Incremental Balance Sheet Policies”). Even faster paces
could be contemplated if the Fed decided that macroeconomic considerations outweighed concerns about market
functioning.

18. It is important to note that large policy moves would still
be possible under the approach in this paper, should the
FOMC believe that economic circumstances warranted theequivalent of a very large rate cut. However, federal funds
rate moves of 1 percentage point or more have happened
only three times in the past 30 years.
19. This proposal is consistent with the recommendation ofÁngel Ubide (2017) to adopt QE as a conventional part ofmonetary policy and to incorporate it into regular policy
communications.

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tinuous, gradated manner. I expect that QE will be used only
occasionally in the future, during more severe downturns,
and then typically in large discrete chunks.”
The signaling effects of implementing QE1 as a large,
one-time program may have been particularly importantbecause it represented a dramatic change in the Fed’s policy
instrument and served as an aggressive response to substantial

The staff’s argument rested on the importance of articulating the stopping rule for purchases under a flow-based
approach. But that is just one dimension through which
the central bank affects the ultimate size of asset purchases.
Indeed, other central banks have ratcheted up and down
their pace of purchases in flow-based programs, highlightingthat the flow-based approach does not reduce the reaction
function to a single decision point. Any information on the
expected end of purchases, or other decisions affecting theultimate size of purchases, could also be conveyed under astock-based policy rule.
Another potential problem with a flow-based rule isthat the FOMC and other central banks may not be fully
comfortable making unlimited commitments with theirbalance sheets. Whenever a central bank specifies conditions
for stopping purchases in a flow-based rule, it runs the riskthat markets would expect it to continue accumulating assets
indefinitely if those conditions are not met, regardless of thelevel of assets already achieved.
Traditionally, central banks have taken the position that
there is an appropriate degree of policy accommodation for agiven state of the economy, rather than an appropriate direction for policy actions. This point is illustrated by the factthat economists typically express the monetary policy rule interms of the level of the policy interest rate, rather than its
change. Indeed, if the effects on the economy are associatedwith the stock of holdings (in the same way that they areassociated with the level of the policy rate), then there arestrong arguments to specify the rule in terms of the stock ofholdings.
In effect, the flow-based rule involves a shift from a “levelrule” to a “difference rule,” in that the amount of purchases
would continue under a given set of economic conditions
regardless of the stock of assets accumulated. There may be
more subtle arguments for moving to a difference rule in thiscontext, such as uncertainty about the effects of the policy
instrument or a desire to create overshooting. In particular,some studies find that policy rules based on the change inthe policy instrument rather than its level may be morerobust to uncertainty about how the economy truly operates (Orphanides and Williams 2002).21 Although there may
be greater uncertainty about the effect of long-term asset
purchases on the economy than about the effect of the policy

QE should be implemented throughan approach that focuses on the stockof long-term asset holdings, adjusts
that stock of holdings in increments of$300 billion (1.5 percent of GDP), anddemonstrates considerable inertia.
stress in the financial markets and the economy. However,in most circumstances a policy approach such as the one
suggested here will be more appropriate, in that it will be
as powerful but will also provide the benefits of the inertial
policy approach that central banks use for their traditional
policy instrument.
Comparison to flow-based programs

The Fed in some ways swung to the other extreme whenit shifted to a flow-based program for QE3. The FOMC
decided to move in policy increments that were smaller thanmost central banks would ever consider for their primarypolicy instrument. Under the mapping described above,
the Fed’s QE3 program involved the equivalent of easing
the policy rate by 0.07 percentage point per month. In thisregard, an even stranger decision was the degree of tapering
at the end of QE3, as the Fed decided that it had to graduallyslow that pace of easing by a minuscule 0.008 percentage
point per month.
Why would a central bank operate in such trivial
steps? The Fed staff argued prior to the launch of QE3 thatdoing so might improve the public’s understanding of the
Fed’s reaction function.20 However, it is not clear whether
implementing such an unusual policy reaction function, onethat differs so much from the manner in which the target
federal funds rate has typically been set, improves the public’s
understanding.

21. Mathematically, an inertial level rule may be viewed as acompromise between a simple level rule and a difference rule:
A simple level rule has a coefficient of 0 on the lagged policyrate, a difference rule has a coefficient of 1, and an inertial
level rule has a coefficient between 0 and 1. If policymakers
are continually revising their estimates of the parameters of
the rule, as, for example, in the recent downshift of estimatesof the equilibrium real interest rate, then the distinction between the two classes of rules is even less sharp.

20. See Jean-Philippe Laforte, David López-Salido, Steve
Meyer, Ed Nelson, and John Roberts, “Flow-Based Balance
Sheet Policies: Communication Issues and Macroeconomic
Effects,” memo, Board of Governors of the Federal Reserve
System, August 28, 2012 (https://www.federalreserve.gov/
monetarypolicy/files/FOMC20120828memo02.pdf).

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interest rate, the difference is a matter of degree, not type,and is likely to narrow over time. Moreover, such concerns
were not articulated by the Fed or other central banks in theirmoves to flow-based QE. As long as level-based rules are
dominant for implementing interest rate policy, stock-based
rules should be the norm for QE.

Nevertheless, in May 2009 the amount to be purchased
was increased by £50 billion (3 percent of GDP) even before
the initial purchases were completed. The minutes noted thatsome committee members wanted an even larger increase andthat the governor would request an increase in the maximum
size of the facility if needed. From that point on, it was clearthat total holdings of long-term bonds would be subject toregular review, and long-term asset holdings were increasedin August 2009, November 2009, October 2011, February
2012, July 2012, and August 2016, reaching a total of £435
billion. The steps ranged in size from £25 billion to £75
billion (2 to 5 percent of GDP).
The approach of the BOE evolved into a form that isroughly in line with the proposal above. It always included
the intended stock of its holdings in its policy statement, andit made frequent adjustments in a typical increment of £50
billion (3 percent of GDP), which would translate into 50
basis points under the mapping described earlier using GDP.
The BOE never explicitly argued that its approach to QE
was similar to its traditional policy framework, but it in effectdelivered the most continuity.
The BOE is currently maintaining its QE holdings at£435 billion and has stated that it does not intend to start
reducing these holdings until after the policy rate has reached“around 1.5 percent.”

QE PROGRAMS IN OTHER COUNTRIESThe above discussion notes that there has been meaningfulvariation in the form of QE implemented in the UnitedStates. There has also been variation in how QE was implemented across central banks, which is useful to review in thecontext of the proposal above.
In all QE programs to date, the main assets being purchased have been longer-term government and governmentguaranteed bonds. In the United States, these are the only
assets that were purchased, while in other countries central
banks have made smaller purchases of corporate bonds,
covered bonds, equities, and real estate investment trusts.22
This paper does not attempt to assess the choice of assets toinclude in QE but instead focuses on the best method for
implementing purchases of longer-term bonds that are intended to affect financial conditions through their impact on
the supply of duration to the market.
United Kingdom

Euro Area

In March 2009, the Bank of England (BOE) lowered its
short-term policy rate, or Bank rate, to 0.50 percent andannounced that it would purchase up to £75 billion (5 percent
of GDP) in medium- and long-term bonds, mainly Treasury
bonds (gilts).23 From the beginning, the BOE stated that“the scale and timing of purchases would be reviewed at each
MPC [monetary policy committee] meeting.” However, theminutes of the meeting suggested members tended to centeron £75 billion as the ultimate size of the program. At the time,
the BOE had negotiated an agreement with the UK Treasury
for an asset purchase facility with a maximum potential scaleof £150 billion, so that £75 billion was at the time not seen as
an incremental step in a much larger program.

The European Central Bank (ECB) had asset purchase programs that were aimed at reducing market stress several years
before the use of QE as a macroeconomic stabilization tool.
In May 2009, the ECB announced that it would purchase€60 billion (1 percent of GDP) in long-term covered bonds.
In May 2010, the ECB began discretionary purchases ofsovereign bonds of member countries that were experiencing
high yield spreads. It announced a second round of coveredbond purchases in October 2011. The goal of these purchases was primarily to reduce yield spreads, restore orderly
markets, and equalize credit conditions across the euro area.
To a large extent, yield spreads reflected market concerns
about the possibility that countries might leave the euro area
and redenominate the assets into new currencies that would
depreciate against the euro. The ECB was determined tocounter the risk of a breakup of the euro area.
In September 2012, the ECB further refined its usageof asset purchases for these financial stability purposes. It
announced it would consider unlimited purchases of sovereign debt of distressed member countries as needed to preventa breakup of the euro, thereby ratifying ECB president Mario
Draghi’s promise in July 2012 to do “whatever it takes.” This
program, named Outright Monetary Transactions (OMT),
clearly separated out asset purchases intended as a backstop

22. Covered bonds are packages of mortgages guaranteedby the issuing bank. Bayoumi and Gagnon (2018) discuss theeffects of central bank purchases of equities in the context
of the Asian financial crisis of 1997–98.
23. The minutes stressed that purchases were a way to easemonetary conditions by increasing central bank reserves(BOE, “Minutes of the Monetary Policy Committee Meeting
held on 4 and 5 March 2009,” March 18, 2009, https://www.
bankofengland.co.uk/minutes/2009/monetary-policycommittee-march-2009). Over time, the BOE moved toward
the Fed’s view that the asset side of its balance sheet is moremeaningful than the liability side in transmitting monetaryconditions.

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October 2018

In April 2013, Haruhiko Kuroda became governorof the BOJ and launched the “quantitative and qualitative
monetary easing” program, so named to distinguish it fromthe earlier “quantitative easing” program. Purchases wouldbe ¥50 trillion per year (10 percent of GDP) of government
bonds with an average maturity of seven years. In addition,
the BOJ would purchase ¥1 trillion per year of equities and amodest amount of real estate assets. The program continued
purchases of commercial paper and corporate bonds at their
existing levels.
In October 2014, the BOJ announced an increased paceof purchases to ¥80 trillion per year (16 percent of GDP) of
government bonds and ¥3 trillion of equities. The average
maturity of the purchases was extended to a range of 7 to 10
years.
In many ways, the policy situation confronting the BOJ
differed from that facing the other central banks consideredhere. Whereas the proposed policy approach is intended toallow the central bank to calibrate the degree of stimulus
correctly to match recent changes in economic conditions,
the BOJ was closer to a corner solution of trying to achieve as
much stimulus as possible. In particular, it was trying to raise
inflation to a new target of 2 percent after a long period inwhich there was no firm target and inflation had been below
zero. It is therefore less productive to assess the form of the
BOJ’s asset purchases in the same context as the other central
banks.
For related reasons, the BOJ in September 2016 moved
to a form of asset purchases that had not been previously usedby other central banks. The BOJ announced a new policyof “yield curve control,” in which purchases would aim to
keep the yield on the 10-year government bond aroundzero. The BOJ estimated that continued annual purchasesof ¥80 trillion would be required under the new policy, but
the emphasis was on the 10-year yield and not the amountto be purchased.24 An evaluation of this approach is beyond
the scope of this paper, and in any case cannot really be
performed until the BOJ manages to exit from that regime.25

against financial turmoil from those that would later be
implemented for achieving monetary policy stimulus. In
the event, the ECB did not make any purchases under thisprogram, as yield spreads narrowed and remained small.
The ECB first used QE to ease overall macroeconomic
conditions in January 2015, when it announced that an
expanded asset purchase program (APP) would begin in
March, composed mainly of long-term government bonds.
The APP was structured in a manner similar to the Fed’s
QE3, with a monthly purchase amount that could be adjusted up or down and that would persist until the ECB’s
inflation goal appeared to be secure. However, the program
also had a large implied total volume, because the ECB said
that purchases were “intended to be carried out until endSeptember 2016” or possibly longer. Initial purchases were
€60 billion per month, which would have been equivalent to10 percent of GDP over the 19 months to September 2016.
Purchases were increased to €80 billion per month in April
2016 with guidance that they were expected to run for at least
12 more months (9 percent of GDP at an annual rate) andthen were lowered back to €60 billion in April 2017. They
were lowered further to €30 billion per month in January
2018 (3 percent of GDP at an annual rate). In June 2018,
the ECB announced that purchases would be taken to zeroby the end of 2018.
This program is somewhat of a hybrid between a large
one-time purchase program and an open-ended flow-based
program. It was specified in terms of the monthly pace ofpurchases. However, by giving guidance on the minimum
length of the program, it was effectively moving in larger
steps than implied by the monthly flows. Possibly the ECB
chose to convey a large up-front total purchase because it
felt behind the curve on its inflation goal by the time theprogram was launched. It may have chosen an adjustablemonthly pace because of the perceived success of the Fed’s
QE3 program.
Japan

The Bank of Japan (BOJ) was the first central bank to
conduct large-scale asset purchases to ease monetary policy
with interest rates at the zero bound. It started in 2000 andlasted until 2006. A second round began in December 2008.
However, these programs were not QE as is currently understood, because they focused on government bonds withremaining maturity of about one year. Indeed, the average
maturity of government bonds held by the BOJ actually fell
between 2000 and 2006 (McCauley and Ueda 2009). The
later program did include relatively small purchases of commercial paper and corporate bonds of about ¥2 trillion and¥3 trillion, respectively, per year.

24. Equity purchases were increased to ¥6 trillion per year
(1 percent of GDP), with a small increase in purchases of realestate assets and constant rates of purchase of commercial
paper and corporate bonds.
25. The calibration of 1.5 percent of GDP in bond purchases
as equivalent to a 0.25 percentage point reduction in the
short-term interest rate may not apply when bond yields
are near or below zero. Even before Japanese bond yields
reached zero, studies suggested that QE purchases (normalized by GDP) had a smaller effect in Japan, perhaps because
the Japanese bond market is larger (relative to GDP) thanbond markets in other countries (Gagnon 2016).

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18-19

OctoberMonth 2018

Table 1 Characteristics of QE programs
Program

Typical step size
Total size
(percent of GDP) (percent of GDP)

Stock/flow focus

Inertia in rule

QE1

Stock

No

4–8

12

QE2

Stock

No

4

4

United States

MEP

Stock

No

2

4

QE3

Flow

Yes

0.5/month9

United Kingdom

Stock

Yes

3

27

Euro area

Flow

Yes

0.6/month

23 (projected)

Japan

Flow

Yes

1.3/month

71 (to date)

Sweden

Stock

Yes

1

7

Proposal

Stock

Yes

1.5–3

As needed

QE = quantitative easing; MEP = Maturity Extension Program
Note: The euro area program is projected to end in December 2018. The Japanese program has
no announced end date; the data are through August 2018. For stock programs, total size isscaled by GDP in the year of announcement. For flow programs, monthly purchases are scaledby annual GDP in the year they occur. Total sizes are the sums of these percentages. 2018 GDP
is the IMF projection.
Sources: Central bank websites, IMF World Economic Outlook (April 2018), and authors’ calculations.

Swedenthe proposal. Moreover, the Riksbank avoided making the
explicit analogy between purchases and changes in the repo
rate, and it downplayed asset holdings relative to the repo
rate in describing its policy stance.

In February 2015, the Riksbank lowered the repo rate to 0.10
percent and started a QE program with purchases of SEK10
billion (0.2 percent of GDP) of long-term government bonds.
QE purchases were increased in 2015 by SEK30 billion in
March, SEK50 billion in April, SEK45 billion in July, andSEK65 billion in October, bringing total planned holdings
to SEK200 billion (5 percent of GDP). The repo rate continued to be lowered, reaching 0.50 percent in February 2016,
where it remains.
QE holdings were increased by another 2 percent of
GDP in three steps in April 2016, December 2016, and April
2017, with holdings reaching SEK290 billion. Redemptions
are being fully reinvested but no further purchases are
expected.26 Interestingly, beginning in February 2018, thesummary statements at the top of the minutes of the monetary policy meetings no longer mention the Riksbank’s holdings of government bonds. The stance of monetary policy is
now described solely in terms of the policy interest rate, andthe debate in the policy committee is focused on when to
start raising the policy rate.
This approach has some similarities to the proposal
made here, in that the Riksbank made frequent adjustments
to the size of its holdings. However, those increments werein steps that appear small relative to the benchmarks from

Summary of the structures of QE programs

The different QE programs that have been implemented
may be summarized with a few key parameters shown intable 1. As can be seen, the proposal in this Brief differs frommost. The programs that have been focused on the stock ofholdings have moved in relatively large increments as a shareof GDP and have generally not conveyed inertia in the policy
response. The programs that have focused on flow, while
having inertia by design, typically focused on the monthly
pace of purchases, which is a small step size as a share ofGDP. The proposal here is intended to focus on the stock ofholdings, to adjust that stock in reasonably-sized steps, and toconvey inertia in QE policy decisions. The BOE’s programin the United Kingdom is closest to this proposal.
CONCLUSION

Ten years ago, the worst financial crisis since the Great Depression led central banks around the world to unleash a new
type of monetary policy called quantitative easing. Given its
novelty, it is not surprising that QE took on different forms
across countries and over time. As central banks experimented
with QE, they gained a better understanding of how it works
and how to calibrate its macroeconomic effects. The time hascome to take advantage of the lessons learned and to incorporate QE systematically into the monetary policy framework.

26. In December 2017, the Riksbank decided to make modest additional purchases in early 2018 in anticipation of ahigh volume of maturing bonds in late 2018 and early 2019.
Holdings should return to target by late 2019.

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gradual runoff of the QE assets. Outright sales of QE assets
would not be ruled out, but the baseline case would require
only the runoff of maturing and redeemed securities.
With interest rates expected to remain at historically
low levels, central banks are likely to encounter the lower
bound on conventional policy interest rates again in the next
recession. Having a well-articulated plan for dealing with thelower bound is essential. Academics and former policymakers
have spoken out on potential approaches that are exploratory
in nature. For example, it may be desirable to raise inflation targets either permanently or temporarily (Ball et al.
2016, Kiley and Roberts 2017, Bernanke 2017) or to adopt
nominal GDP targeting (Sumner 2012, Beckworth 2017,
Frankel 2018).
Those are changes that, while worth discussing, have
only a limited probability of being implemented by the next
recession. In contrast, a return to QE is highly likely once
the next economic downturn arrives. It is therefore surprisingthat determining the right approach for QE has received little
attention relative to these other exploratory policy options.
This paper is intended to encourage that discussion andspecifically to present a proposal that will maximize theability of central banks to achieve their economic goals in anenvironment of sustained low real interest rates.

Most central banks intend for QE to take over fromthe short-term policy interest rate when that rate reaches
a level beyond which further cuts are either not possible
or not helpful. Within that context, there are advantages
for choosing a policy approach for QE that resembles theapproach taken with the short-term interest rate.
Such an approach would have several key dimensions.
First, asset purchases would focus on the stock of holdings oflong-term assets rather than the monthly flow of purchases;
second, long-term asset holdings would be changed in termsof reasonably-sized steps, calibrated to have effects comparable to typical (0.25 percentage point) changes in the
traditional policy interest rate, which research suggests to be
increments of 1.5 percent of GDP; and third, asset purchasedecisions would be expected to have considerable inertia, sothat a central bank wishing to make a large policy adjustment
likely would implement it in several steps. The comparability
in the policy rule between the conventional interest rate andQE purchases should make communicating policy intentions
easier.
When it comes time to reverse course and tighten policy,
the framework currently employed by the Federal Reserve
works well: raise the conventional policy interest rate first
until it is significantly above its lower bound, then allow a
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PIIE Policy Brief
18-19, QE: A User’s Guide by Joseph E. Gagnon and Brian Sack. Originally published in October 2018 by thePeterson Institute for International Economics (PIIE). https://piie.com/publications/policy-briefs/qe-users-guide.

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