Can quantitative easing really stimulate the economy?

[John Creighto]

Quantitative easing doesn’t actually have an impact on the real economy. It is an asset swap whereby the Federal Reserve buys Treasury bonds and sells dollars it prints out of thin air. After the asset swap, the primary dealer which sold the Treasuries to the Fed now has cash instead of Treasuries and the Fed has Treasuries instead of the cash. While the new money can ostensibly be lent out because the transaction has created reserves, the reality is that this money will sit in a bank vault idle unless the demand for loans warrants otherwise. It is a misunderstanding of how the banking system works to assume the mere creation of reserves has any significance in regards to lending. In fact, I would argue the swap is deflationary because it drains the economy of interest-bearing assets that add to income, replacing them with non-interest bearing assets. Why would we want the Fed to print money then if we know this will just create excess reserves as it did when the Fed began credit easing last year?

http://www.creditwritedowns.com/201...-not-going-qeii-until-after-the-election.html

I thought the above was termed open market operations as opposed to quantitative easing. I also thought quantitative easing was when the fed bought corporate assets instead of bank assets. Buying assets from the bank only increases the money supply if the banks actually lend the money out but if the bank needs more reserves it can always borrow them from the federal reserve.

I'm not sure if banks need liquidity but corporations certainly do or at least did and if banks weren't lending to corporations then it would make much more sense for the fed to buy assets directly from the corporations rather then using the banks as an intermediary.

What buying treasures from banks does is props up their value. It is really a way of funding the United States debt rather then helping to inject liquidity into the economy. Granted government spending has a stimulus effect but this seems as an indirect approach.

 

[loseyourname]

The Fed can buy any kind of debt (well, within a range) under the QE program. Some of it is corporate debt, which they purchase from banks because it is mostly owned by banks, but doing so still increases the liquidity of corporate debt securities, theoretically reducing the liquidity premium and thus their borrowing costs.

However, as you seem to be getting at, the main intended effect is to stimulate bank lending, but if banks simply choose to sit on the reserves, the intended effect won't occur. There isn't much the Fed can do about that. They could lower the reserve requirement as an absolute last resort, but even then, banks don't have to lend. The Fed can't force them to. Plus, the increasing default risk premium in a rough economy with uncertain cash flows can entirely offset the reduced risk-free rate produced under open market operations and the liquidity injected by QE, producing no net effect, other than, as you said, the deficit spending of the federal government, which will definitely not just sit on any cash added to the Treasury by Fed t-bond purchases, but that type of spending relies upon congressional action, which is by design slow, responsive, and inefficient.

Nonetheless, everything I've seen in the corporate debt market regarding yields indicates to me that the cost of capital for any decently-sized firm right now is very low, almost historically low. Even so, as you also point out, there still has to be borrowing demand, which is driven by the opportunity for profitable corporate investment, not by low interest rates. Investment-timing options are very valuable in an uncertain future cash flow environment, especially with the possibility of sweeping political changes on the horizon, so you're going to see what you see, a lot of sitting on the sidelines and waiting.

 

[talk2glenn]

http://www.creditwritedowns.com/201...-not-going-qeii-until-after-the-election.html

I thought the above was termed open market operations as opposed to quantitative easing.

Open market operations are a tool; quantitative easing is an objective. Specifically, the object is an increase in the money supply to stimulate demand.

Reserve banks lack the means to forcibly change M1, whether or not banks are bypassed in favor of some other favored consumer. Banks were chosen for their efficiency of distribution; generally they represent the best option for currency market manipulation, for obvious reasons.

Given the laws of markets, central banks use baskets of tools to push things in desired directions, with predictable effects. But it is an imprecise game. The Fed cannot simply issue a mandate that the money supply go up any more than an engineer can mandate a rocket reach the moon.

 

[Gradient]

I had a few implementation questions on QE. I have emailed the education arms of some Fed Reserve banks for answers, but to no avail. This thread seems an appropriate place for them...here goes:

How does the Federal Reserve force banks to buy securities (in order to put cash on their balance sheets)? I understand that some banks might want to swap securities for cash, but what if other banks don't want to? For example, if the Fed wants to pump $600B into the economy, but banks are only wanting to sell/swap $300B of securities? Does the Fed pay them a higher than market value on these securities? Perhaps the securities they hold have higher yields than the market can provide; if the market is yielding higher rates, what is to prevent these banks from re-investing the cash the Fed just swapped for lower yielding securities into the higher yielding, market rate securities?

During the crisis, the Fed swapped cash for other non-treasury securities, how were these securities valued, i.e. how much cash did the Fed know to give the banks?

Thanks!

 

[WhoWee]

The Fed can buy any kind of debt (well, within a range) under the QE program. Some of it is corporate debt, which they purchase from banks because it is mostly owned by banks, but doing so still increases the liquidity of corporate debt securities, theoretically reducing the liquidity premium and thus their borrowing costs.

Anything as large as QE-2 will undoubtedly have unintended consequences.
http://online.barrons.com/article/SB50001424052970204552604575554072192257734.html

There has been some concern regarding state debt.
http://www.businessinsider.com/federal-reserve-buying-muni-debt-2010-10

"Is Bernanke Going To Start Printing Money To Buy California State Debt?"

Bernanke has stated publicly that he won't bail out CA.

 

[WhoWee]

http://www.creditwritedowns.com/201...-not-going-qeii-until-after-the-election.html

I thought the above was termed open market operations as opposed to quantitative easing. I also thought quantitative easing was when the fed bought corporate assets instead of bank assets. Buying assets from the bank only increases the money supply if the banks actually lend the money out but if the bank needs more reserves it can always borrow them from the federal reserve.

I'm not sure if banks need liquidity but corporations certainly do or at least did and if banks weren't lending to corporations then it would make much more sense for the fed to buy assets directly from the corporations rather then using the banks as an intermediary.

What buying treasures from banks does is props up their value. It is really a way of funding the United States debt rather then helping to inject liquidity into the economy. Granted government spending has a stimulus effect but this seems as an indirect approach.

These links referring to "liquidity traps" might prove useful. Please recognize experts disagree.
http://econ.economicshelp.org/2009/10/liquidity-trap-explained.html

http://web.mit.edu/krugman/www/trioshrt.html

http://charlesrowley.wordpress.com/2010/02/15/paul-krugman-on-the-liquidity-trap/

IMO - Krugman has a strong grasp on Keynes when interest is suppressed to zero, during a long and deep recession, with massive Government (stimulus) spending, and while printing money (QE-2).

The real question is what will happen when interest rates are increased - is hyper-inflation possible?

 

[WhoWee]

There are also two unresolved bubbles to consider - (US) housing and (global) derivatives.

The problem in 2008 was the banks needed more cash - correct?

Now, after QE-2 - the banks will have cash. The pending question might be -will market corrections be allowed to take place at that time?

 

[TheodoreLogan]

There are also two unresolved bubbles to consider - (US) housing and (global) derivatives.

The problem in 2008 was the banks needed more cash - correct?

Now, after QE-2 - the banks will have cash. The pending question might be -will market corrections be allowed to take place at that time?

I think it was that people needed the cash as the banks became insolvent. Not so much that the banks needed cash, other than to honor their on demand accounts held by people.

The real question is what will happen when interest rates are increased - is hyper-inflation possible?

Increasing interest rates is a tool used to combat inflation. Increasing interest rates is not even a possibility right now. In order to bring back the housing market they are going to have to remain low for some time. I would say that hyper-inflation is very possible as it is. Especially if the confidence in the dollar is lost around the world, then we will be in serious trouble, as all of those dollars will end up back here, further inflating the money supply that has already grown so much from the various bailouts and stimulus packages.IMO