Final answer:
Quantitative Easing (QE) was a key strategy used by the Federal Reserve to aid economic recovery following the recession, which involved purchasing risky mortgage-backed securities from banks. This non-traditional monetary policy helped to lower interest rates and remove toxic assets from financial institutions, stabilizing and strengthening the financial system.
Step-by-step explanation:
During the period of recovery after the recession, the Federal Reserve (the Fed) used an unconventional monetary policy known as Quantitative Easing (QE) to help stabilize the economy. This included the purchase of risky mortgage-backed securities from banks, an action aimed at providing liquidity to financial markets and supporting the housing sector. Unlike traditional monetary policy, which primarily involves the trading of Treasury securities, QE allowed the Fed to buy private securities directly from the market, thus influencing long-term interest rates and improving the balance sheets of financial firms by removing toxic assets.
The process can be understood through different episodes of QE:
- QE1 started in November 2008 with the Fed purchasing $600 billion in mortgage-backed securities from entities like Fannie Mae and Freddie Mac.
- QE2 began in November 2010, focusing on the purchase of $600 billion in U.S. Treasury bonds.
- QE3, which started in September 2012, involved the Fed buying $40 billion in mortgage-backed securities each month, an amount later increased to $85 billion per month.
By doing so, the Fed not only managed to push down long-term interest rates but also contributed to correcting valuations in the mortgage market by removing risky, possibly worthless assets, and thus ensuring a degree of financial stability.
In addition to QE, legislative measures like the Troubled Asset Relief Program (TARP) and the American Recovery and Reinvestment Act played key roles in stabilizing the financial market and providing economic stimulus.