Open Market Operations vs.

Quantitative
Easing: What’s the Difference?
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By MATTHEW JOHNSTON
 Updated Jul 3, 2019
Open Market Operations vs. Quantitative Easing: An
Overview
The U.S. federal reserve was created by the Federal Reserve Act in 1913. Since
its establishment, it has held responsibility for a three-part mandate which
includes: maximizing employment, stabilizing prices, and monitoring interest
rates. All three pieces of the Fed’s responsibilities can be analyzed individually
and holistically. Monitoring price level movements is central to understanding the
U.S. economy. Since 2012, the Fed has targeted a 2% inflation rate which it uses
as a guide for price movement. The Fed follows the labor market’s employment
capacity and analyzes unemployment along with wage growth in correlation with
inflation. The Fed also has the ability to effectively influence interest rates on
credit in the economy which can have a direct effect on business and personal
spending. 

With responsibility and authority to take actions for the optimization of these three
key areas, the Fed can deploy several tactics. Here we will discuss the Federal
Open Market Committee’s authority to take monitory policy actions and strategies
it uses by looking at both open market operations and quantitative easing.

Open Market Operations

The Federal Open Market Committee has three main tools that it uses to take
action for achieving its three-part mandate. Those actions include: open market
operations (OMO), setting the federal funds rate, and specifying reserve
requirements for banks.

Open market operations are a tool that allows the Fed to buy and sell securities
on the open market, influencing the open market price and yield of specified
securities. Most commonly the Fed will utilize Treasury securities for open market
operations but it can also use other types of securities. Following the 2008
Financial Crisis, the Fed used mortgage-backed securities as part of its open
market operations.
In general, buying debt securities in the open market increases their price and
lowers the yield. Selling debt securities decreases the price and increases the
yield. The Fed often uses open market securities in tandem with its stance on
interest rates. Thus, when it is seeking to increase rates it would need to sell
securities and vice versa. Generally, the Fed only uses debt securities in open
market operations with a focus on Treasuries.

In addition to open market effects, the buying and selling of securities also affects
the Fed’s balance sheet. OMO consists of the Fed either expanding or
contracting its balance sheet through either buying or selling securities on the
open market.

Quantitative Easing
Tactically, the Fed can seek to deploy holistic monetary policies that utilize
several of its tools in order to achieve an objective. Quantitative easing is one
strategy that historically has been used by the Fed.

The phrase quantitative easing (QE) was first introduced in the 1990s as a way

to describe the Bank of Japan's (BOJ) expansive monetary policy response to
the bursting of that country’s real estate bubble and the deflationary pressures
that followed. Since then, a number of other major central banks, including the
U.S. Federal Reserve, the Bank of England (BoE), and the European Central
Bank (ECB), have resorted to their own forms of QE. Although there are some
differences between these central banks’ respective QE programs, we'll look at
how the Federal Reserve’s implementation of QE has been effective.

QE was used following the 2008 Financial Crisis to help improve the health of the
economy after widespread subprime defaults caused major losses resulting in
broad economic damage. In general, policy easing refers to taking actions to
reduce borrowing rates to help stimulate growth in the economy. Keep in mind,
quantitative easing is the opposite of quantitative tightening which seeks to
increase borrowing rates to manage an overheated economy.

From September 2007 through December 2018, the Federal Reserve took
quantitative easing steps, reducing the federal funds rate from 5.25% to 0% to
0.25%, where it stayed for seven years. In addition to decreasing the federal
funds rate and holding it at 0% to 0.25%, the Fed also used open market
operations.

In this case of quantitative easing, the Fed used both federal funds rate
manipulation and open market operations to help reduce rates across maturities.
The federal funds rate reduction focused on short-term borrowing but the use of
open market operations allowed the Fed to also decrease intermediate and
longer-term rates as well. As mentioned, buying debt in the open market pushes
prices up and rates down.

The Fed implemented large-scale asset purchases in multiple rounds from 2008

to 2013:

 November 2008 to March 2010: purchased $175 billion in agency debt,

$1.25 trillion in agency mortgage-backed securities, and $300 billion in
longer-term Treasury securities.
 November 2010 to June 2011: purchased $600 billion in longer-term
Treasury securities. 
 September 2011 through 2012: Maturity Extension Program—purchased
$667 billion in Treasury securities with remaining maturities of six years to
30 years; sold $634 billion in Treasury securities with remaining maturities
of three years or less; redeemed $33 billion of Treasury securities. 
 September 2012 through 2013: purchased $790 billion in Treasury
securities and $823 billion in agency mortgage-backed securities.

After four years of holding the new assets on the balance sheet, the Fed’s QE
goals had reportedly been achieved and were markedly successful. As such, the
Fed began the process of normalization in 2017 with an end to principal
reinvestments. In the years following 2017, the Fed plans to use open market
operations in somewhat of a tightening mode with staged plans for selling
balance sheet assets in the open market.

KEY TAKEAWAYS

 Open market operations are a tool the Fed can use to influence rate
changes in the debt market across specified securities and maturities.
 Quantitative easing is a holistic strategy that seeks to ease, or lower,
borrowing rates to help stimulate growth in an economy.
 Open market operations can be an important tool used in seeking to obtain
the goals and objectives of quantitative easing.
Understanding OMO Goals
While the buying and selling of securities through OMO can have several goals,
one of the main goals is to manipulate interest rates across maturities. Overall,
buying large quantities of debt securities will increase the price in the open
market and push the rates down. Alternatively, selling large quantities of debt
securities in the open market will reduce the price and increase rates.

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