The great recession that occurred in the period between late 2007 to mid-2009 was primarily caused by a severe disruption in the financial sector. The issue of providing incentives in the mortgage market gave rise to defects in the financial regulatory structure of the United States resulting in a global financial crisis (Joyce, Miles, Scott, & Vayanos, 2012). The crisis led to collapse in the United States real estate market, mortgage default, and disintegration of the financial market that were closely associated with these mortgages. During such extreme economic crisis, most of the traditional monetary policy tools may not be effective to restore the economy to normal. Therefore, the Federal Reserve developed unconventional monetary policies that can be utilized to trigger economic growth and stimulate demand.
Quantitative Easing (QE) is one of the unconventional monetary policies utilized by the Fed to stimulate the economy especially when the normal monetary policy has become ineffective because of extreme economic conditions. A central bank implements this policy by purchasing financial assets from commercial banks and other financial institution in the economy (Cecchetti, 2008). This, in turn, increases the prices of those financial assets, decrease their yield and increase the money supply in the economy. The key financial instruments purchased when using Quantitative Easing is bonds and other debt instruments such as mortgage-backed securities.
The main advantage of Quantitative easing is that it increases the money supply thus jump-starting the economy and stimulating demand. Other key benefits of quantitative easing include prevention of unemployment, total government control among others.
On the other hand, the key disadvantage of quantitative easing is that it increases inflation, results in fluctuation in interest rates, fluctuating exchange rates, and may result in business cycles. According to Joyce et al. (2012), quantitative easing creates business cycles as it increases the availability of money thus creating a boom. Finally, quantitative easing creates asset bubbles resulting in an increase in asset prices in the market.
Joyce, M., Miles, D., Scott, A., & Vayanos, D. (2012). Quantitative easing and unconventional monetary policy–an introduction. The Economic Journal,122(564), F271-F288.
Cecchetti, Stephen G. (2008). Money, Banking, and Financial Markets, 2/e McGraw-Hill.