Quantitative easing 101

Some readers have written to me asking to explain what quantitative easing is. Some of them had heard an ABC 7.30 Report segment the other night which interviewed the Bank of England Governor who outlined the BOE’s plan to “print billions of pounds” as its latest strategy to stimulate lending and hence economic activity in the very dismally performing UK economy. Once again we need to de-brief and learn what quantititative easing actually is. We need to understand that it is not a very good strategy for a sovereign government to follow in times of depressed demand and rising unemployment. We also need to get this “printing money” mantra out of our heads.

What is quantitative easing?

With very tight credit markets at present (that is, banks have upped their lending standards and made it harder for firms and households to access credit), central banks have started talking about using what is called quantitative easing to free up credit flowing especially as short-term interest rates fall towards zero. In fact, near zero interest rates are required if the central bank is to engage in quantitative easing!

Quantitative easing merely involves the central bank buying bonds (or other bank assets) in exchange for deposits made by the central bank in the commercial banking system – that is, crediting their reserve accounts. The aim is to create excess reserves which will then be loaned to chase a positive rate of return. So the central bank exchanges non- or low interest-bearing assets (which we might simply think of as reserve balances in the commercial banks) for higher yielding and longer term assets (securities).

So quantitative easing is really just an accounting adjustment in the various accounts to reflect the asset exchange. The commercial banks get a new deposit (central bank funds) and they reduce their holdings of the asset they sell.

Proponents of quantitative easing claim it adds liquidity to a system where lending by commercial banks is seemingly frozen because of a lack of reserves in the banking system overall. It is commonly claimed that it involves “printing money” to ease a “cash-starved” system. That is an unfortunate and misleading representation.

Invoking the “evil-sounding” printing money terminology to describe this practice is thus very misleading – and probably deliberately so. All transactions between the Government sector (Treasury and Central Bank) and the non-government sector involve the creation and destruction of net financial assets denominated in the currency of issue. Typically, when the Government buys something from the Non-government sector they just credit a bank account somewhere – that is, numbers denoting the size of the transaction appear electronically in the banking system.

It is inappropriate to call this process – “printing money”. Commentators who use this nomenclature do so because they know it sounds bad! The orthodox (neo-liberal) economics approach uses the “printing money” term as equivalent to “inflationary expansion”. If they understood how the modern monetary system actually worked they would never be so crass.

Crucially, quantitative easing requires the short-term interest rate to be at zero or close to it. Otherwise, the central bank would not be able to maintain control of a positive interest rate target because the excess reserves would invoke a competitive process in the interbank market which would effectively drive the interest rate down.

The Bank of England has now cut short-term interest rates to virtually zero (the lowest since the BOE was formed in 1694) in the misguided belief that monetary policy could solve the demand failure they are facing. While still eschewing fiscal policy (spending and taxation) they now have nowhere to go with monetary policy unless they begin to engage in quantitative easing. As a consequence, over the next three months they intend to spend £150bn buying assets from the private sector called gilts (which are just government bonds) and also high quality corporate debt.

The aim is to increase liquidity in the credit markets and encourage banks to increase lending to companies as explained above.

Does quantitative easing work? The mainstream belief is that quantitative easing will stimulate the economy sufficiently to put a brake on the downward spiral of lost production and the increasing unemployment.

It is based on the erroneous belief that the banks need reserves before they can lend and that quantititative easing provides those reserves. That is a major misrepresentation of the way the banking system actually operates. But the mainstream position asserts (wrongly) that banks only lend if they have prior reserves. The illusion is that a bank is an institution that accepts deposits to build up reserves and then on-lends them at a margin to make money. The conceptualisation suggests that if it doesn’t have adequate reserves then it cannot lend. So the presupposition is that by adding to bank reserves, quantitative easing will help lending.

But this is a completely incorrect depiction of how banks operate. Bank lending is not “reserve constrained”. Banks lend to any credit worthy customer they can find and then worry about their reserve positions afterwards. If they are short of reserves (their reserve accounts have to be in positive balance each day and in some countries central banks require certain ratios to be maintained) then they borrow from each other in the interbank market or, ultimately, they will borrow from the central bank through the so-called discount window. They are reluctant to use the latter facility because it carries a penalty (higher interest cost).

The point is that building bank reserves will not increase the bank’s capacity to lend. Loans create deposits which generate reserves.

The reason that the commercial banks are currently not lending much is because they are not convinced there are credit worthy customers on their doorstep. In the current climate the assessment of what is credit worthy has become very strict compared to the lax days as the top of the boom approached.

The major formal constraints on bank lending (other than a stream of credit worthy customers) are expressed in the capital adequacy requirements set by the Bank of International Settlements (BIS) which is the central bank to the central bankers. They relate to asset quality and required capital that the banks must hold. These requirements manifest in the lending rates that the banks charge customers. Bank lending is never constrained by lack of reserves.

While some point to the quantititative easing experience in Japan between 2001 and 2006, the reality is that it was highly expansionary fiscal policy not the monetary policy gymnastics which kept that economy from deflating and allowed it to return to stronger growth in recent years (until the crisis hit).

We should be absolutely clear on what the BOE is doing. It is buying one type of financial asset (private holdings of bonds, company paper) and exchanging it for another (reserve balances at the BOE). The net financial assets in the private sector are in fact unchanged although the portfolio composition of those assets is altered (maturity substitution) which changes yields and returns.

In terms of changing portfolio compositions, quantitative easing increases central bank demand for “long maturity” assets held in the private sector which reduces interest rates at the longer end of the yield curve. These are traditionally thought of as the investment rates. This might increase aggregate demand given the cost of investment funds is likely to drop. But on the other hand, the lower rates reduce the interest-income of savers who will reduce consumption (demand) accordingly.

How these opposing effects balance out is unclear. The central banks certainly don’t know! Overall, this uncertainty points to the problems involved in using monetary policy to stimulate (or contract) the economy. It is a blunt policy instrument with ambiguous impacts.

The major problem facing the economy at present is that there is not a willingness to spend by the private sector and the resulting spending gap, has to, initially, be filled by the government using its fiscal policy capacity. I prefer direct public sector job creation to be the principle fiscal vehicle. But fiscal policy it has to be. Then when the negative sentiment is turned around, private borrowing will recommence and investment spending will grow again. Then the economy moves forward some more and the budget deficit falls.

So I don’t think quantitative easing is a sensible anti-recession strategy. The fact that governments are using it now just reflects the neo-liberal bias towards monetary policy over fiscal policy. What will motivate consumers to borrow if they are scared of losing their jobs? Why would a company borrow if they expect their sales to be depressed? The problem is a failure of demand which has to be addressed via demand measures – that is, fiscal policy. Overall, you can only take a horse to water ….!

There are also those that claim that quantitative easing will expose the economy to uncontrollable inflation. This is just harking back to the old and flawed Monetarist doctrine based on the so-called Quantity Theory of Money. This theory has no application in a modern monetary economy and proponents of it have to explain why economies with huge excess capacity to produce (idle capital and high proportions of unused labour) cannot expand production when the orders for goods and services increase. Should quantititative easing actually stimulate spending then the depressed economies will likely respond by increasing output not prices.

I hope that explains what is going on for all those who asked and for others who are interested! Have a nice weekend.

This Post Has 44 Comments

  1. Dear Scott and Warren, Thanks for the nice comments. It seems that there is a great number of people who are wondering what quantitative easing is, and, further, there are a great number of people who purport to know what it is who don’t! But at least the central banks are driving rates towards zero which then makes them a “one trick” pony (they only have quantitative easing left) which will fail. Then desperation will push governments around the World to more pro-active and larger fiscal interventions. Then we should see some turnaround.
    best wishes

  2. Great article. Hope you’ll write more ‘101’ articles in the near future…

  3. Dear Rahul
    Thank you for your nice comment. If you have any 101 Debriefing topics in my area of research that you are interested in me analysing please let me know. That goes for anyone out there. I have several topics that will emerge in the coming months when I get some time.
    best wishes

  4. Thanks for this explanation. One bit I don’t understand though, is the bank reserves. According to my research, banks in a lot of countries, including Australia, England, and Canada (where I am from) have no reserve requirements. This of course validates your statement that loans do not depend on available reserves, but on having worthy borrowers. But it does not explain why the central banks would then be trying to do this. Do they not know that there is no reserve requirement?

  5. Dear Alan

    This is a good point. The only reserve requirements are that they are positive balances. Central banks seem to believe that if the member banks have excess reserves they will lend them out to avoid hold below-market rate assets. I doubt this will happen. What they need are credit worthy customers.

    best wishes

  6. “This might increase aggregate demand given the cost of investment funds is likely to drop. But on the other hand, the lower rates reduce the interest-income of savers who will reduce consumption (demand) accordingly.” The US consumer has no savings but faces enourmous liabilities and cashflow constraints due to first and foremost mtge payments. To the extend that long term rate are lower via TSY (lower rates) and Mtge pruchases (lower spreads and rates) the dire cashflow situation of the consumer has potential to improve while the positive capital investment incentives remain. Thus the Fed’s to attempt lower long term rates has its place in the current experience. Having said that I would not that we learned on Tuesday that the Fed has not intention to sterilize its QE: From the NY Fed’s web site. “Will these operations be reserve neutral? No, these operation will be financed through the creation of bank reserves.”

  7. This plus the blog on Money Multiplier were crisp and thrilling indeed and have left me with lot of thinking. Thanks for making my month! However I have one thing to say/ask. According to Ben Bernanke, the reserves themselves are not important and in fact the other side of the balance sheet is. That is why he calls it Credit Easing and not Quantitative Easing. Whats important is to bring down the whole yield curve and also the mortgage rates. He has been not so successful till now about the treasury curve, but the mortgage rates have come down. In fact he seems happy with the reserves staying idle. So in that sense doesnt it make sense. Dont you think its effect will show up soon ?

  8. “Credit Easing” is an appropriate term where the process involves purchasing securities other than Government bonds, particularly mortgage-backed securities. In Australia, the Australian Office of Financial Management (AOFM) rather than the Reserve Bank has been doing just this. The aim in this case has nothing to do with increasing reserves, which, as Bill notes, can already be managed by the usual Reserve Bank market operations, but to support the non-bank mortgage lenders (who are perceived to provide health competition to the major banks) who rely on issuance of mortgage-backed securities to operate, but have found that the demand in the private market for these securities has dried up.

  9. Couple Questions:

    1) Isn’t your argument that quantitative easing does not equal printing money simply an argument over semantics as realistically it’s really just electronic 1’s and 0’s, but doesn’t quantitative easing still increase the money supply?
    2) You claim that the increase in the money supply may simply lead to higher output and not increase in price. Doesn’t the price have to first increase to reflect the increased demand, with the possibility of higher output following assuming it takes longer to increase output (more machines, factories, labor, etc.)?

  10. I agree that the “printing money” terminology can be quite misleading and causes confusion for folks. Instead in my writings, I refer to the creation of “bank reserves” or “reserves” when the Fed conducts unsterilized purchases or unsterilized loans where cash is swapped for collateral (sterilized purchases or loans are simply debt swaps and have no effect on reserves). However, it is incorrect to assume that Central Bank asset purchases (resulting in the creation of bank reserves) never increase deposit money (money supply).

    There are situations where Central Bank asset purchases results in both an increase in bank reserves and deposit money (increasing narrow money supply). It depends on the counter-party involved in the purchase (are the proceeds landing in a deposit account?). But much of the reserve creation that has taken place since September w/respect to the Federal Reserve has been solely reserve creation (simply resulting in credits to member institution reserve accounts at the Fed). This is in concert with the current goals of the Fed … to recapitalize the banks with as little inflation as possible. This is also where the Fed payment of interest on reserves comes into play. Other prior programs in support of this goal entailed the sterilization of Fed purchases and loans (via the Treasury Supplemental Financing Program and the Fed’s program of treasury sales).

    Incidentally, the Bank of England in recent months has been specifically targeting the purchase of longer term bonds because they tend to not be held by commercial banks (purchase from these counter-parties results only in an increase of bank reserves). Instead, they are typically held by insurance companies or pension funds (purchases from these counter-parties result in an increase of bank reserves and deposit money (increasing narrow money supply)). Hence, this brand of QE is increasing money supply.

    Also, banks can increase money supply in ways other than lending off of their reserve base. They can elect to invest their excess reserves … in say treasuries.

    Finally, a comment on something you wrote …
    “The point is that building bank reserves will not increase the bank’s capacity to lend. Loans create deposits which generate reserves.”
    I want to make sure you are not implying that bank lending creates reserves in aggregate, because it does not. The Fed creates reserves, not the banks. When a bank loans money, reserves are credited to the bank of the borrower making the deposit (reserves increase for this bank). But the lending bank sees its reserves decline. The aggregate amount of reserves in the system does not change.


  11. Sean asked:
    1) Isn’t your argument that quantitative easing does not equal printing money simply an argument over semantics as realistically it’s really just electronic 1’s and 0’s, but doesn’t quantitative easing still increase the money supply?


    No, it is not a semantic argument. There is a very real difference between Central Bank purchases that only create bank reserves (does not increase money supply) and Central Bank purchases that create bank reserves and deposit money (increases money supply). The author makes the assumption that Central Bank purchases only create bank reserves (which is not accurate) and never create deposit money (at least he leaves that impression as he does not address this scenario). However, the author is much more correct than the “printing money” sensationalists. That said, I do not share the author’s opinion on the ultimate outcome of all of this reserve creation. I believe that it will results in inflation, for a bevy of reasons that are not addressed in this article.


  12. Good blog. Have you thought of engaging with Scott Sumner at the Money Illusion? He avowedly believes that monetary policy alone could fix the shortfall in AD. Would love to know your thoughts.


  13. QE has been accompanied (certainly in the UK) by a budget deficit. Thus rather than consider QE in the abstract, as most of the above commentators do, is it not more useful to look at the NET effect of “QE plus deficit”? This renders superfluous many of the points made above.

    I’ll expand on this. Deficit equals “1, wealthy individuals and institutions give money to government/central bank machine, 2, government/central bank machine spends this money, 3, government/central bank machine gives treasuries/gilts to wealthy individuals and institutions”. QE equals reversing items 1 and 3. Thus the only NET effect is 2, which certainly should be stimulatory or reflationary.

  14. Dear Ralph

    Governments borrow back the funds they have already spent. So 1 = 2 and 2 = 1 in your scheme. Clearly QE + deficit is the policy stance but unless QE (by altering returns along the yield curve) stimulates demand, all the expansion is coming from fiscal policy. It is unlikely that QE is doing that. The logic of QE – “to give the banks more money so they might lend more” is plain wrong.

    best wishes

  15. GILES: Thanks for drawing attention to Sumner. On your recommendation I just read his Cato essay. Interesting. I don’t think Sumner is unique in claiming that “monetary policy alone can fix the shortfall in AD”. E.g. see Warren Mosler’s blog: http://www.moslereconomics.com/ See in particular “Mosler’s law” in yellow at the top of each page: “There is no financial crisis so deep that a sufficiently large tax cut or spending increase cannot deal with it.” I agree with the latter, but not with all of Mosler’s ideas.

    Sumner’s distinctive idea is that we should “target the forcast”. This is new to me, and I certainly don’t flatly disagree. I’ll need to sleep on this one !

    BILL: I agree with your last two sentences. I agree that 1 and 2 are numerically the same (assuming the simple case where deficit equals amount quantitatively eased). As for the rest, I am not sure whether you are agreeing, disagreeing or making incidental points. Can you expand?

  16. http://ukhousebubble.blogspot.com/

    What do you make of this Bill? Here is a claim that the quantity of reserves held by British banks boosted by QE is now falling. The argument in the link is that they are being loaned out to inflate a new housing bubble.

    I thought that British banks would be unable to eliminate these excess reserves, only shuffle them between each other. Furthermore, since loans create deposits, I would expect any increased lending to merely add to the overall quantity of deposits.

    Is something draining out excess reserves or is this person just hopelessly wrong?


  17. Dear Lefty

    Thanks for the link. I think your assessment is the correct interpretation of what is going on. The writer is operating in a money multiplier world. As you note, the “excess reserves” can only be drained by central bank or treasury operations. I think her terminology is very confusing – all this talk of pumping things into the economy doesn’t give us a very clear idea of the actual way the operations work.

    The banks are slowly starting to lend again – but very slowly. This means some confidence is returning and more credit-worthy customers are being identified. The loans generated will create new deposits in the banking system. But the bank’s capacity to lend was not enhanced by the QE, which was about reducing longer maturity interest rates in the hope that investment would be stimulated (it hasn’t been!).

    Conclusion: The person is hopelessly wrong (in your words).

    best wishes

  18. Thanks for that Bill and ParadignShift.

    ParadigmShift, when you say that there has been reverse repo activity (I’m not an economist) exactly what does that mean? How does the central bank drain excess reserves held by the commercial banks?

    Sounds almost as if they have concluded that QE did not have the effect it was supposed to have.


  19. Lefty

    I don’t profess to have any significant economic background either, and I expect those with more knowledge will correct me if I’m wrong – but essentially a repo is a type of collateralised loan, where a dealer exchanges a security for cash, and buys back the security at the end of a predefined term. A reverse repo is a repo from the point of view of the other counterparty.

    A repo = cash in, security out, reverse repo = cash out, security in.

    For some reason, probably just to confuse people like me, central banks view repo transactions the other way around, and so a central bank reverse repo withdraws bank reserves, while a central bank repo does the opposite.

    They are short term operations that help to fine tune the level of bank reserves in the system, so the effect is temporary.

    Hope that doesn’t confuse more than it helps…

  20. Hi Bill,

    (I do not know where to ask this question but think this post is the best one).

    Central bank and government together represent Government sector and all claims about debt monetization are misplaced. However, when central bank purchases obligations/assets of private sector (high grade corporate bonds or goods) it is a proper monetisation of private sector and therefore net financial assets increase in economy.

    Typically (if not everywhere) central bank mandates include statements about emission of currency (say, M1). And all people in the world are sure that it is a profitable business line of business. Central banks are subject to the same accounting rules as any other entity in the economy, i.e. they have p&l statements as well as balance sheets. I did not look at many of those but took one of my own country (no language-related confusions) But I was still very confused. There was no line on p&l statement about income from emission. Moreover, I realized that I have no clue how emission is reflected in the balance sheet statement. So if central bank purchases corporate bonds they should appear on the asset side. But then where do they appear on the liabilities side? If M0 or M1 reflects central bank emission, then the change in any given year should be reflected 1-for-1 somewhere in the balance sheet. It looks like emission is the whole liabilities side of the balance sheet (apart from capital) but I find this intentionally confusing. But then going to p&l statement, back the change in M1 should appear in the income statement as income 1-for-1.

    I feel very confused now. Could you please explain it? Thank you

  21. Hi Sergei,

    Let us say that the central bank (Fed) buys 1M units of corporate bonds each worth $100 from a corporate, say Microsoft issued by Microsoft itself. here is how to describe it: 10M x $ 100 = $100M – Fed’s assets increases by $100M because a bond is an asset for the holder. Let us say Microosft has an account at BoA. The Fed instructs BoA to increase Microsoft’s account by $100M. Since this is a liability for BoA, it (the Fed) compensates BoA by increasing BoA’s account at the Fed by $100M. Both accounts increase electronically. If computers hadn’t been invented, it would have happened on pieces of paper. Microsoft’s assets and liabilities have increased by $100M, BoA’s assets and liabilities have increased by $100M and the Fed’s assets and liabilities have increased by $100M. This is useful for Micorosoft since it could find a lender but the private sector which here is Microsoft and BoA has not gained in net worth. It is true that reserves have increased but banks do not need the reserves to lend. The role of reserves is for settlement between banks and anything you do to manipulate the reserves does not achieve much.

    There is another scenario one can come up with. The Fed buys the bonds from a dealer instead of Microsoft. Let us say that the dealer is not a bank. When the Fed buys the bonds from the dealer, the dealer’s account at its bank, say JPM in this case increases by $100M and JPM’s reserves increase by $100M but it has an increase in liabilities because of new deposits created. Here, the dealer just exchanged one asset for another, so again no increase in net worth.

    Always good to look at “money” as an IOU. When the government is included in all this, the situation is different. Also note the government has to spend and not buy financial assets for the private sector net worth to increase.

  22. Ramanan,

    honestly I am as confused as I was before. Central bank is part of government but it has balance sheet (and ministry of finance or government do not have balance sheet). So when central bank buys assets, it should be reflected in its liabilities as well. Liabilities to whom?

    Then not everything central bank buys is financed by emission, e.g. central bank has operating income. So liabilities in this case are different.

  23. Sergei,

    Reserves are central bank liabilities. These are liabilitis to the private banks. Take a simpler example: The central bank buys $100M corporate bonds from these private banks. Its a simple transaction. The private banks assets are still the same – it now has $100M of reserves more than before and $100M of corporate bonds less than before. The size of the balance sheet has not changed. The central bank however has $100M increase in assets and liabilities – corporate bonds and reserves, respectively.

  24. @Ralph Musgrave (Tuesday, October 13, 2009 at 19:50

    You write:

    Deficit equals
    1, wealthy individuals and institutions give money to government/central bank machine,
    2, government/central bank machine spends this money,
    3, government/central bank machine gives treasuries/gilts to wealthy individuals and institutions.

    QE equals reversing items 1 and 3. Thus the only NET effect is 2, which certainly should be stimulatory or reflationary.

    In the context of studying inflationary effects, items 1 and 3 are not inverses (they do not equal each other out) (since in item 1 money is transferred, and in item 3 treasuries are transferred). So I’m confused by what you’re saying. The net effect is not item 2, right? I would instead change the text in your list and look at it like this (also the order of events in the list, but that’s secondary here)

    Deficit spending equals:

    1. The government issues new money and spends it.
    2. A likely effect is a change in inter-bank lending rate. To compensate for that and retain control over the rate (in attempt to indirectly control inflationary effects), the government will drain the private sector of the excess reserves, perhaps by selling treasury securities.

    The NET effect for the private sector as a whole is an increase in treasury securities, but no change in money. An shock increase in money supply could very well be inflationary, but a corresponding increase in treasury securities would not.

    I think.

  25. Hi Bill,

    Despite it’s apparent government entity-ness (it being a private organisation), the Bank of England must somehow profit by this Quantitative Easing – because that’s what banks and bankers do. Following the money should tell us who wins by QE but it’s out of my league to do that.

    Can you shed any light on what profit there is to BOE or anyone else in the decision loop?

  26. Quantitative easing merely involves the central bank buying bonds (or other bank assets) in exchange for deposits made by the central bank in the commercial banking system – that is, crediting their reserve accounts.

    Hi Bill,

    I follow your blog pretty regularly and very much appreciate all your time for spreading the knowledge. The above line, I have always found it difficult to understand. You say QE is transfer of asset(s), meaning they purchase treasuries from the banks and provide them with cash (or credit their reserve accounts) so they can go and chase/invest for a positive return or lend it. But where does this cash come from in order for the Fed to purchase the treasuries? I mean, I know its not revenue constrain but isn’t that indirect new money created? I am sure I am missing something here. Please kindly explain. Thank you once again.

  27. Quantitative easing is Spreadsheet Voodoo 101. Ex nihilo credit. In and of itself and interesting triangulation of different types of debt. Regrettably you portray people as crass for failing to understand the ‘modern monetary system’. As if the brave new economic hologram is unrelated to collapse.

    Ordinary people know that to defy gravity is illusory. Quantitative easing is quintessential Postmodern monetarism. If it wasn’t so ‘trendy’ I’d be all for it.

  28. The central problem with all of these explanations is that the fundamental cause of these instabilities is not acknowledged or addressed. For an economy to grow, an increase in GDP needs to be fueled by increasing energy inputs and absorbed by increased stress on the environment. In the Friedman universe where the environment is an externality not subject to the inherent physics of the macroeconomy, GDP can increase indefinitely as the stress on the biosphere and rising energy demand both happen outside of the quantifiable system. This idea of our economic system means that the energy supply is unquantified and therefore infinite, and the ability of the biosphere to absorb waste is limitless because it is outside of the calculated capacity of the economy. The solution to the instability of recent years is, unfortunately, not a matter of a return to growth through whatever means. We have created an economic understanding of our world which is akin to an understanding of a human body which is only studied by its internal processes but not by its reliance on inputs of oxygen, fresh water and food. Should one or all of the three vital ingredients of life be limited or suspended, the body will suffocate, starve, thirst and eventually die. In a study only of the body’s interior, everyone can argue about whether it is an electric shock or an adrenaline shot which is needed to resuscitate the corpse, but without oxygen, fresh water and food, no amount of medical or scientific intervention will allow the body to live past the withdrawal of its external life support inputs.

    Unfortunately, between the excessive drawdown of our planet’s biocapacity, the profligate wasting and subsequent peaking of fossil fuels and the utter willful ignorance of “qualified” economists and politicians to recognise, plan for and adjust our societies to the natural limits our planet has, we now find ourselves in a position where we are trying to resuscitate a corpse in the absence of food, water and oxygen. Whether quantitative easing works to ameliorate the pinch of the current recession or not, the fact that the world economy (more specifically the US and the UK) has reached the limit of its ability to command continuously increasing energy inputs while simultaneously structuring the entire system around a requirement for sustained annual growth means that sadly our ill-conceived Ponzi scheme is coming to an end. Our economy can no longer bear the weight of the deregulation that created the orgiastic blow out of derivatives and other financial instruments that inflated only our hubris and sense of invincibility rather than our genuine production. Our economy can no longer sustain a monetary system that creates a debt burden on citizens merely to have a circulating currency. Our economy can no longer support the heft of money created only as debt, in whatever form, be it binary or cotton. We owe too much, for a lifestyle we no longer have, on a planet that we have plundered greedily.

    The reality check is in the mail.

  29. Very good article, although after reading the entire peice, I disagree with your opening statement that QE is not “printing money”. If the government is exchanging hard federal assess (cash) for bonds, securites, and other subjectively valued vehicles, isn’t the government putting more into the system than it is taking out, essentially adding more money? It may not be “printing” money, butcertainly increases the net money supply, leading to the same result.

  30. “It may not be “printing” money, butcertainly increases the net money supply, leading to the same result.”

    Which is nothing. Unless money is de-stocked (ie spent) then it does nothing. There is no increase in the amount of assets in the hands of the private sector. The central bank has taken one liquid asset out of the system (a government bond) and replaced it with another liquid asset (cash). Unless that increases the amount of spending then nothing will change.

    The assumption you are working on is that cash is somehow magically spent if you create it. Well it isn’t – the statistics are pretty clear on that.

  31. @Ramanan

    This is all nice and well, but what if Microsoft (replace with some other firm) goes broke? The FED loses an asset and private sector loses a liability. Isn’t this a net gain in financial assets for the private sector? Bank reserves are risk free top hierarchy assets, corporate bonds are not. And is everybody Microsoft or are there some less worthy corporate bonds being bought?


  32. @Mike
    “For an economy to grow, an increase in GDP needs to be fueled by increasing energy inputs and absorbed by increased stress on the environment. In the Friedman universe where the environment is an externality not subject to the inherent physics of the macroeconomy, GDP can increase indefinitely as the stress on the biosphere and rising energy demand both happen outside of the quantifiable system.”

    I know this is quite a bit of time after you’ve posted your original comment. But I simply don’t see why it is the case that an increase in GDP needs to be fueled by increasing energy inputs and absorbed by increased stress on the environment. For many years the growth rate of real gdp for the world has been faster than that of energy consumption. Of course this doesn’t mean that we should not seek to do something about the strain the environment that our energy consumption imposes. A lot of research is done in the field of alternative energy sources; hopefully at some point one or some of these energy sources will replace the current ones. Also a lot people don’t know this, but Friedman was actually in favour of imposing a pollution tax that would incentivise people and businesses to behave in a way that minimizes pollution.

    Best regards,

  33. Great article !
    I have two questions.
    1) Its just accounting change for private sector banks but isn’t QE indirectly supplying cheap money to Govt. as Govt is supplying Treasury on request from Fed ?
    2) I read somewhere that Fed is owner by private sector banks, how much truth is in that?

  34. Bill,

    Re: Your analysis of Ralph’s point about Individuals and bank lending to government being equal to government spending of this money.

    It seems to me that you are making an assumption that all money lent to government must originate from government. This is not the case however. Currency is given legitimacy by government, but when a business or individual takes a loan, that money is newly created. It can be spent on gilts or food shopping… but it didn’t come from government. The increase in money supply as a result of private banks issuing loans to individuals is licensed by government, but not created by government.

    Have I misunderstood something?

  35. One thing overlooked in discussion of QE is the fact that in buying Tsy securities from the banks, the Fed
    has effectively in most cases been taking up the national debt. The Fed will then take mature securities
    and swap them for new securities with the Treasury–at some point when the economy looks headed for
    inflation. When the Tsy gets the securities it extinguishes them. If the security was used to fund a deficit,
    this redeems the security and cancels a portion of the national debt. The Fed will then sell its new securities with new future maturity dates to banks and private investors to drain bank reserves and money out of circulation.
    Note too that in these transactions the Fed is not funding spending on the deficit, so Tsy securities are not
    created solely to fund the deficit. The Fed has new securities to sell. They were not created to fund a deficit.
    Could this have been the real reason for QE in connection with buying Tsy securities from banks. (Tsy and
    Fed can swap securities. They are prohibited in Fed creating money to buy securities directly from the Tsy.)

  36. Interesting article. Would you mind explaining the statement, ” I prefer direct public sector job creation to be the principle fiscal vehicle”. Competition in the private sector drives efficiency and innovation. If your statement meant, “more civil servants”, how would you suggest an efficient and innovative culture could be created in the public sector in order to make it socially and politically worthwhile?

  37. @Paul D: ” Competition in the private sector drives efficiency and innovation”.

    Yes, but the private sector rarely produces full employment. That’s where the public sector is required. (Hence the JG of MMT).

  38. Bill,

    I asked my macro professor about QE (essentially swapping reserves for treasury securities) and how it seems to me that it is simply a portfolio composition change rather than adding “money” in the economy. She said that the Fed creates reserves (that weren’t there before) to then buy the bonds in the private sector, which is essentially increasing the money supply. Am I missing something here? Is my professor missing something? Help!


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