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What Is: Quantitative Easing?

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Quantitive Easing is a monetary policy action used by central banks to purchase various financial assets from financial institutions in amounts that are pre-determined before the purchase to ensure that only an exact quantity is injected into the economy.  

What Does QE Do For Financial Institutions?

QE provides banks with new capital while removing illiquid or generally undesirable assets from their balance sheets. Financial institutions are left with excess cash reserves which are beneficial for two reasons:

  • With more cash in hand, firms can lend and invest more while remaining properly capitalized and thus better protected from insolvency risk. 
  • The central bank purchases balance sheet liabilities, which helps lower a firm’s debt and credit risk, making them more attractive for investment. 

What Does QE Do For The Central Bank?

This type of stimulus usually requires that new money be created so that the central bank can make the purchases it plans. Because new money is created and added to the existing supply, inflation increases. The national debt also increases, because the assets purchased by the central bank are usually illiquid short-term investment products (assets with maturities of less than one year) which add liabilities to the central bank’s balance sheet. 

Why Do QE?

When a central bank has already used open market operations to lower interest rates to near-zero levels but economic productivity doesn’t increase, it resorts to directly capitalizing firms with new money so that the recipients can increase lending and investment. The central bank gambles that raising inflation and increasing the government’s debt load will generate enough long-term economic growth that future tax reciepts (the government’s primary revenue stream) will offset the short-term risks of buying “toxic” assets from banks. 

Anything Else We Should Know?

Quantitative Easing is one of the last things that a central bank wants to do, considering that a central bank’s primary function is to keep inflation at a relatively stable level. QE intentionally raises inflation in the hope that the financial firms that receive the funds will invest them into the general economy at a rate that will produce siginificant increases in economic activity. In this lies the danger, because a central bank (usually) cannot compel private banks to lend or to invest, and thus must trust private firms to actually put the additional capital to use. If they don’t, the central bank essentially raises inflation to take on excessive amounts of risk which will remain until it can sell the assets back on the market. Such a problem is best evidenced in the United States, where the Federal Reserve System has issued hundreds of billions of dollars to the nation’s major commercial and investment banks while seeing only modest reductions in unemployment and tepid economic growth.  

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About Alexander J Smith III

  • pablo

    Hi Alexander,

    I was just wondering…. Where does the $40,000,000,000 that the FED uses to buy these so called assets come from?

  • Alexander J Smith III

    Pablo,

    You really don’t know when to quit do you lol.

    When the Federal Reserve wants to make these kinds of purchases, the money they use can come from one of two places. Either the U.S. Treasury prints new money for the FED to use, or it goes to the revenue from its SOMA portfolio. Though usually, because of the amounts in question, Treasury prints more money and then the FED makes purchases.

  • pablo

    So let me get this straight Alex. The amount in question that the FED has lent out in the last several years is 16,000,000,000,000. The current Soma portfolio as of 2011 is at 2.6 trillion. So you are telling me that the US mint actually printed 14,000,000,000,000 worth of federal reserve notes. Is that what you are saying Alex? According to you the money comes from one of two places. I suggest to you that this is bullshit, plain and simple.

    As to me not knowing when to quit, I suggest it is you that does not know when to quit. At least when I used to write article for this site, I would have hundreds of comments. Yours elicit nada, that is because nobody cares to comment on boring articles.

  • Alexander J Smith III

    Pablo,

    We’ve already been through this $16 trillion figure, and as I said before, that number does not account for the maturity of the loans offered to each of those banks nor does that data reflect what was actually used. Table 9, the very next data set, shows you the actual amounts offered adjusted for maturity which is a more accurate representation of what was disbursed by the FED. It’s also good to note here, that said figure is no where near 16 trillion.

    What’s interesting is that you actually think it would matter to me that when you used to write here you had plenty of comments. To that, i say only that sensationalism very quickly draws a crowd. Honestly I write for BC because I wanted to have content editors. So I could care that much less about the traffic you claim to have once driven lol.

  • http://cinemasentries.com El Bicho

    Speaking of not knowing when to quit, under the name Pablo, you had only one article that garnered hundreds of comments, and most of them disagreed with you.

  • Igor

    There is a persistent notion that the government (or the Fed) “prints” money to cover debts, etc., but it is not true. Actual printing of money is quite modest and is mainly for the purpose of replacing worn out currency. There is only about $900billion of actual currency in circulation, and about half of that has disappeared into various national vaults and private sequestrations.

    The need for printed money goes up and down based on shortterm needs for folding money, cash, and that goes up as the population expands and down as cash-equivalents (like plastic) substitute for actual cash.

    There is nowhere near as much cash in circulation as there is annual transactions. In fact, that tips the game: why tie cash amount to annual cash flow, why not monthly or weekly, or whatever?

  • pablo

    Exactly Igor, this is the point I was trying to make to Alexander, but it went over his head. He said:

    “When the Federal Reserve wants to make these kinds of purchases, the money they use can come from one of TWO PLACES. Either the U.S. Treasury prints new money for the FED to use, or it goes to the revenue from its SOMA portfolio. Though usually, because of the amounts in question, Treasury prints more money and then the FED makes purchases.

    I pointed out to him that as of 2011, the SOMA porfolio was at 2.6 trillion. The fact of the matter is that most of the money that the FED issues is not printed at all but electronic, so that kind of leaves the US Mint out of the equation.

  • Alexander J Smith III

    -Pablo,

    But what you miss is that the FED is issuing the money, not actually creating it which has been my thesis all along. Consider how the FED electronically credits and debits the accounts of its Reserve Banks, through the sale or purchase of securities, usually Treasury Bonds. Interesting point about treasury bonds, they’re created and issued by the U.S. Treasury. The FED, through Open Market Ops can choose to purchase these securities from banks in exchange for dollars or sell securities to banks for the dollars they have in reserve. But the FED doesn’t actually create the dollars that it uses, nor does it create the securities its buying/selling, because it legally doesn’t have the authority to do so. It’s able to make purchases because of the interest it makes off of holding securities in SOMA, not because it, itself, creates new money and that’s the point