From lifeline to lifestyle: How quantitative easing became the Fed’s default setting

The nomination of Kevin Warsh has renewed scrutiny of the Federal Reserve’s expanding role in the economy. One of the most consequential shifts in US monetary policy since the 2007-08 crisis is the rise of quantitative easing (QE). Under QE, the Federal Reserve buys large quantities of Treasury and mortgage-backed securities to inject liquidity and suppress longer-term interest rates.

These holdings accumulate on the Fed’s balance sheet, which is a running record of its assets and liabilities. As a result of QE, the balance sheet has grown dramatically since the Great Recession. While originally introduced as a crisis response, QE has persisted well beyond its initial purpose.

A new CEI policy memo highlights how far the central bank’s balance sheet has drifted from its traditional framework of open market operations in short-term Treasuries. Before policymakers can debate how to shrink the balance sheet, they must understand how it grew so large in the first place.

Monetary policy before the expansion pack

Before 2008, the Federal Reserve’s balance sheet was relatively small and largely unremarkable. Monetary policy operated primarily through short-term interest rate targeting, with the Fed adjusting liquidity conditions to keep the federal funds rate near its desired level.

Assets were primarily limited to Treasury securities, and the central bank did not engage in large-scale interventions that affected the allocation of credit across markets or sectors. In this regime, the balance sheet was a passive accounting tool instead of being an active policy lever. That pre-crisis framework defined the modern operating norm for decades and now stands in sharp contrast to the expanded post-crisis balance sheet.

When persistently low interest rates changed everything

The 2007–08 financial crisis marked a turning point for the Federal Reserve’s operating framework. As financial markets froze and the federal funds rate approached zero, the Fed encountered the zero lower bound (ZLB), limiting its ability to cut short-term interest rates further. In response, the Fed turned to unconventional tools centered on large-scale asset purchases.

QE rapidly expanded the Fed’s balance sheet and introduced a new operating model in which asset purchases became a central component of monetary policy alongside interest rates. What began as an emergency response ultimately reshaped the structure and scope of modern US monetary policy.

When monetary policy learned new tricks

Large-scale asset purchases quickly became a recurring feature of Federal Reserve policy following their initial use in 2008. The Fed returned to quantitative easing in QE2 (2010–2011), QE3 (2012–2014), and again during the COVID-19 crisis in 2020. Each episode reinforced the role of balance sheet expansion as a standard response when short-term interest rates approached the effective lower bound.

As the Federal Reserve Bank of San Francisco notes, such conditions led policymakers to rely on unconventional tools, including asset purchases, when traditional rate policy was limited. Over time, the recurrence of these interventions across multiple episodes contributed to a more extensive shift in central banking practice.

Yet many of the policymakers who endorsed quantitative easing during the crisis emphasized its temporary and contingent nature. As then-Bank of England Governor Mervyn King stated, QE was part of “extraordinary policy stimulus” and was viewed as “temporary support” that needed an exit strategy.

Similarly, Federal Reserve Chair Ben Bernanke described how the Fed’s balance sheet would eventually be unwound in a “passive and predictable” manner, with normalization delayed until short-term interest rates were well away from the ZLB. At a minimum, this implies that Bernanke viewed QE as designed for extraordinary conditions at the ZLB instead of as a permanent feature of monetary policy.

Despite that initial framing, the post-crisis policy literature increasingly describes QE as part of an “ever-expanding tool kit,” in which unconventional instruments such as large-scale asset purchases became standard components of policy at the ZLB.

The stimulus that won’t come off the IV

The COVID-19 crisis marked a significant escalation in the use of quantitative easing. Beginning in March 2020, the Fed resumed large-scale asset purchases by acquiring Treasury securities and mortgage-backed securities at a pace far exceeding earlier rounds of quantitative easing.

The Fed’s balance sheet expanded by roughly $3 trillion within a matter of months, a rate of increase that compressed years of prior expansion into a single quarter. Earlier rounds of quantitative easing were implemented in discrete, pre-set phases. In contrast, the COVID-19 QE was initially open-ended, with purchases conducted “in the amounts needed” to stabilize financial markets.

If the Great Recession blurred the line between conventional and unconventional monetary policy, 2020 erased it.

Before the shrinkage, the diagnosis

Over the past eighteen years, repeated rounds of asset purchases have moved quantitative easing from a supporting implementation tool to a primary instrument shaping financial conditions. That evolution has expanded the Fed’s footprint in markets and raised broader questions about institutional scope and the Fed’s mission creep.

The nomination of Kevin Warsh has renewed attention to these issues, particularly given Warsh’s criticism of what he described as “the Fed’s bloated balance sheet.” What reversing this trajectory would entail and how markets would respond has been less fully examined. That issue sits at the center of the next phase of the debate.