It seems everyone has heard of quantitative easing, (QE), but hardly anyone knows what it is.
People think QE, as used in the US and UK since the financial crisis, and still in use in the EU and Japan, is free money for the banks and will lead to rampant inflation. It really isn’t and it really doesn’t.
In reality, QE is merely an asset swap where investors receive bank deposits in return for government securities.
Government securities are bonds issued by the Federal Reserve on behalf of the government, that provide a guaranteed return on investment.
The Federal Reserve is the US’ central bank. It holds two types of accounts: reserves, and securities.
A treasury security is equivalent to having a term deposit at the Federal Reserve. For an individual, this is comparable to a savings account at a retail bank. But if you buy a treasury security, you get the value of your purchase back with interest. (Savings accounts earn interest too, of course, but it pales in comparison to the return on a treasury security. Term deposits, on the other hand, get a similar ROI to securities).
Quantitative easing simply replaces these term deposits with transaction accounts, in the form of reserves at the Fed, for banks, and deposits with banks, for the rest of us.
Reserve accounts are used by banks to make payments to each other, or to the government, and to purchase currency from the Fed, (or Bank of England or Bank of Japan, the European Central Bank etc).
Economist, Dr Steven Hail tells Renegade Inc. that the private sector as a whole gets reserves at the Fed for government securities.
“Reserves at the Fed are interest bearing government liabilities,” he says. “So are government securities. What’s more, government securities pay higher interest in general than reserves at the Fed. QE is simply the replacement of term deposits at the Fed, which is what government securities are, with transaction accounts at the Fed, which is what reserves are.”
Economist, professor Warren Mosler recently explained that swapping assets on the balance sheet of the Fed is not creating new net aggregate demand.
“If you have a million dollars in a securities account and you sell to the Fed, then you have a million dollars in a reserve account,” he said. “They are both bank accounts at the Fed; there is functionally no difference. The only reason they call it ‘printing money’ is that securities are not counted as money, because back in 1933, reserve accounts were convertible into gold, and security accounts were not.”
The purpose of QE is to encourage economic activity by keeping long-term interest rates lower than they would otherwise be. QE tends only to occur as interest rates drop towards zero.
But as economies move closer towards recovery, the US has begun phasing back its QE programs, moving towards Quantitative Tightening in a bid to increase interest rates.
QE has become a pejorative in popular parlance as a hand-out for the private sector. But in reality, it has done nothing significant to keep industries afloat.
“How can the exchange of two very similar government liabilities for each other be a hand-out?,” says Dr Hail. “Only fiscal policy can do that.”
“QE is not a hand-out to the private sector, and people who say otherwise are simply demonstrating that they don’t understand how the monetary system works.”
Professor Randall Wray recently told Real Progressives that people have the impression that QE is a bail out for the banks, but he says this is a result of Ben Bernanke not understanding the role of the Federal Reserve, (of which he was the former Chairman).
“They wanted to lower long-term interest rates thinking they could reboot another mortgage bubble, which in itself is a stupid idea,” he said, “by pumping bank reserves into the system, buying government bonds from the banks and eventually mortgage backed securities.”
In reality all it did was reduce bank earnings.
“They used to earn 3%-5% on government bonds, now it’s 25 basis points which is .25 of 1% of holding reserves,” he said. “It reduces profits. It didn’t stimulate profits at all. If anything it made them less profitable. QE was not a bank bail out. We already bailed out the banks, with an alphabet soup of special facilities. QE was not one of those things.”
In reality it is risk-free interest rates that sit above zero which provide the handout.
“QE has nothing to do with that,” says Dr Steven Hail.
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