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Quantitative Easing for Dummies

Posted by WARREN MOSLER on December 17th, 2008


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FACTBOX: What is quantitative easing?

Tue Dec 16, 2008 3:30pm EST

NEW YORK (Reuters) – The Federal Reserve on Tuesday cut its target for overnight interest rates to zero to 0.25 percent, bringing it closer to unconventional action to lift the economy out of a year-long recession.

“The message is they’re instituting quantitative easing on a fairly large scale,” said Doug Roberts, chief investment strategist at Channel Capital Research.com.

Under quantitative easing, central banks flood the banking system with masses of money to promote lending.

Central banks exchange non or low interest bearing assets- reserve balances- for longer term higher yielding securities.

Since lending is in no case ‘reserve constrained’, the ‘extra’ reserves do nothing for lending.

The purchase of the longer dated securities results in lower longer term rates than otherwise. The lower borrowing rates may or may not alter aggregate demand.

The lower rates for savers definitely lowers aggregate demand.

They usually do this when lowering official interest rates no longer is effective because they already are at or near zero.

True!

The central banks add cash by buying up large quantities of securities — government debt, mortgages, commercial loans, even stocks — from banks’ balance sheets,

Yes.

giving them plenty of new money to lend.

No, they already and always have infinite ‘money to lend’.

Available funds are not a constraint for the banking system.

The constraints are regulated asset quality and capital requirements that are expressed in the rates bank charge.

Not the total quantity of funds available.

It is a tool used by Japan earlier this decade to combat deflation and stimulate the economy.

Didn’t work then either. It was fiscal policy that kept them afloat, though not a large enough deficit to sustain output at full employment levels.


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66 Responses to “Quantitative Easing for Dummies”

  1. Norme Says:

    Mr Mosler, getting over the idea the government can spend without restraint will be a hard pill to swallow. One can easily envision inflation with higher taxes and the inefficiency the government is famous for. If uncle Sam has money, surely the health care industry will come with hat in hand. So will many welfare recipients, wanting more, of course.

    Reply

    WARREN MOSLER Reply:

    could be, but facts are facts, and it’s a simple operational fact that fed govt spending is not revenue constrained.

    Reply

  2. Rentier Fungicide Says:

    Mr. Mosler:

    Thanks for this — I am just working through MMT bit by bit?

    I know you posted this in 2008, but three questions:

    By “savers”, are you referring mainly to those on fixed incomes?

    Would not savers’ lower consumption, in a context of lower interest rates, more than be offset by higher general household consumption?

    Are you assuming that monetary policy (with interest rates at such low levels even in 2008) is now pretty much powerless to further stimulate demand?

    Thanks for your helpful post, speeches and books!

    Reply

    WARREN MOSLER Reply:

    savers in that context means those earning interest- savers vs borrowers

    Reply

    John O'Connell Reply:

    @WARREN MOSLER,

    “savers in that context means those earning interest- savers vs borrowers”

    I think it means those who spend their interest income.

    In stereotypes, those whose only means of support is earnings on their net financial assets, accumulated in previous periods. I.e., retired people.

    Many working people are both savers and borrowers. Many savers do not spend their interest earnings, they let them compound and live off their wages. Their current consumption is not reduced by lower interest rates. In fact, given the prospect of diminished returns on savings, they may be more likely to spend their current earnings than to add them to savings, where their buying power will wither away over time.

    Reply

  3. RJ Says:

    An MMT economy would collapse with in a year in a hyperinflationary holocaust.

    Given commercial banks all the reserves they want ! Lol they would buy up the world and get the money back the next minute.

    There are some really dumb people on the internet.

    Reply

    WARREN MOSLER Reply:

    Bank in japan us uk etc always have all the reserves they want

    Reply

    RJ Reply:

    @WARREN MOSLER
    Can a bank ask for a get 50 Trillion dollars in reserves?

    Reply

    Neil Wilson Reply:

    @RJ,

    They don’t want 50 Trillion dollars.

    They get what they need to stop the payment system freezing up.

    WARREN MOSLER Reply:

    Up to capital constraints

    roger erickson Reply:

    @RJ, RJ, you’re proving your own point. Warren may have gotten tired of saying it, but please read his 7Dif book on this very site.

    Also William Vickrey: http://www.columbia.edu/dlc/wp/econ/vickrey.html

    Also Marriner Eccles: http://fraser.stlouisfed.org/docs/meltzer/ecctes33.pdf

    Also Ben Franklin:
    http://etext.virginia.edu/users/brock/webdoc6.html

    http://www.philadelphiafed.org/publications/economic-education/ben-franklin-and-paper-money-economy.pdf

    An “MMT Economy” holds the ability to scale a nation’s economy to new heights, or new depths. Like all tools, it’s only a question of becoming smart enough to use it – i.e., exploring options.

    After you’re done reading, try some of that exploration too, it’ll do you & your co-citizens some good.

    Reply

  4. RJ Says:

    No they don’t. The aggregate level of reserves is decided by monetary policy.

    Reply

  5. RJ Says:

    “They dont want 50Trillion dollars”

    Lol – they’re a for-profit organization. Of course the would want 50Trillion – they just wouldn’t want it to carry any cost to them.

    According you MMT nutjobs a bank will be happy to have X trillion in reserves – but now I have one of you saying they wouldn’t.

    Make your mind up.

    Reply

    MamMoTh Reply:

    @RJ,

    right, that’s why reserves are never for free in nominal terms at least.

    Reply

    Neil Wilson Reply:

    @RJ,

    “they just wouldn’t want it to carry any cost to them.”

    But it does carry a cost for them. Borrowed reserves aren’t free – they carry a penalty interest rate. Plus the banks are regulated entities and wanting that level of reserves (out of odds with everybody else) rings alarm bells about their solvency.

    So by signalling that to the regulators they put themselves at risk of being put into administration.

    Which wouldn’t go down well with their equity holders.

    The system is always at dynamic tension, but the key point, as shown in spades by the ‘credit crunch’ is that central banks will not shut down banks for cash flow reasons. Therefore reserves cannot be a constraint on their operations.

    Reply

    WARREN MOSLER Reply:

    with a 10% capital ratio, for example, bank liabilities are limited to that multiple. 1 million in capital means you can only have 9 million in ‘borrowings’/deposits/reserves, etc. If you have more the regulators are supposed to shut you down,

    Reply

    RJ Reply:

    @WARREN MOSLER,
    Capital ratios and calculated against asset / capital not liabilities / capital under Basel.

    Reserves carries a 0% risk weighting. No regulator is going to shut down a bank who has plenty. Do the math.

    WARREN MOSLER Reply:

    all liabilities are also ‘instantly’ assets

    MamMoTh Reply:

    @WARREN MOSLER,

    Do regulators consider borrowed reserves as capital?

    WARREN MOSLER Reply:

    no, liabilities/assets

    Neil Wilson Reply:

    “Do regulators consider borrowed reserves as capital?”

    Not as far as I can tell.

    Sergei Reply:

    @WARREN MOSLER,

    RJ: “No regulator is going to shut down a bank who has plenty”

    Well, this is a little bit away from the reality. Both from the internal risk management point of view as well as external regulations. At the very least and to my knowledge US banks are still constrained by the leverage ratio.

  6. RJ Says:

    @Neil Wilson,

    Are you talking MMT world here? Build up of reserves are a natural consequence of MMT, no?

    Reply

    Neil Wilson Reply:

    @RJ,

    There is a difference between borrowed reserves, and reserves representing ‘excess savings’.

    As Warren would say ‘please read 7dif, thanks’.

    Reply

  7. RJ Says:

    @Neil Wilson,
    Why – both can be invested – one just carries a higher cost. Cost of borrowing from the central bank is less that borrowing from a money market – which banks are more than happy to do.

    Are you also saying the people who own the excessive savings that cause these excess reserves cannot expect to receive a rate of interest? Doesn’t bode well for currency acceptance.

    Reply

    MamMoTh Reply:

    @RJ,

    I don’t think borrowing in the money market increases the reserves of the banking system, unless you are talking about people depositing cash.

    Reply

    WARREN MOSLER Reply:

    borrowing increases liabilities, and the borrowed funds are assets

    Reply

    MamMoTh Reply:

    @WARREN MOSLER,

    you didn’t read what I wrote.

    WARREN MOSLER Reply:

    and lost the context, sorry. been working from a cell phone mostly. please repeat

  8. RJ Says:

    @MamMoTh,
    I was talking about the cost of borrowing in the capital markets. It is greater than borrowing from the central bank. Banks are happy to borrow from the capital markets so they would be equally happy to borrow from the central bank. Inferring that they wouldn’t because of penalty rates is ridiculous.

    Reply

    MamMoTh Reply:

    @RJ, nobody said they wouldn’t, just that they will not do it for free as you originally claimed.

    Reply

    RJ Reply:

    @MamMoTh,
    I claimed no such thing. What I said is if you force large amounts of reserves on a bank – they will no exactly what to do with them. Such currency debasement gives them the incentive to acquire assets. Why is it debasement – because they have a mass of liabilities which have no hope of ever receiving value over time.

    Reply

    MamMoTh Reply:

    @RJ,

    My understanding is that if banks want to acquire assets, and are permitted to do so, they just create the needed deposits, and look for reserves later if required.

    There is no such things as forcing large quantities of reserves into the banking system. It’s all about the cost of reserves to sustain the fund rate.

    Sergei Reply:

    @RJ,

    RJ: Banks are happy to borrow from the capital markets so they would be equally happy to borrow from the central bank. Inferring that they wouldn’t because of penalty rates is ridiculous.

    So why don’t they do it?! RJ, your claims with regards to how and what drives banks, reveal some lack of knowledge about banks. I would stop pretending that you know what is ridiculous and what is not.

    Reply

    RJ Reply:

    @Sergei,

    Jeez, thinking is not your strong point is it.

    The Fed only lends money according to its policy objectives.

    Centrals banks main objectives are not the provision of funding.

    Reply

    Sergei Reply:

    @RJ,

    RJ, I guess it was your own claim. Do you contradict yourself or simply trolling?

  9. RJ Says:

    @MamMoTh.

    Maybe you need to turn the reply button on ?

    “My understanding is that if banks want to acquire assets, and are permitted to do so, they just create the needed deposits, and look for reserves later if required.”

    This is such a simplistic view. What’s Banks consider are its cash flows. It will write loans according to its current cash holdings; the amount of cash it can expect to borrow for settlement and at what cost; expected inflows; and its own capital position. If the bank treasury is sitting a pile of zero maturity cash the incentive is to disburse that cash into productive assets. Overnight borrowing and net outflows will not problem with such large cash position. Problem is every bank will be doing the same – so even though net settlement positions don’t change much, the balance sheets grow at a far greater pace.

    Why do you think central banks have to sterilise liquidity injections?

    Reply

    MamMoTh Reply:

    @RJ,

    Why do you think central banks have to sterilise liquidity injections?

    To sustain the funds rate.

    Reply

  10. RJ Says:

    @MamMoTh,
    Yes – a monetary policy objective. Setting the price of money by limiting its supply. What happens to the price when there is plenty of supply?

    Reply

    MamMoTh Reply:

    @RJ, price is fixed, supply floats

    Reply

    RJ Reply:

    @MamMoTh,
    You’ve just contradicted yourself.

    “Funds Rate”

    Reply

    MamMoTh Reply:

    @RJ,

    No, I haven’t.

    You probably have, since you are making no sense at all.
    Good luck!

  11. RJ Says:

    Yes you have. Funds rate – the interest you have to pay to borrow reserves. This interest rate is the price. How much it costs you. If you alter the aggregates level of reserves you are affecting its price – this made you have said. Supply and price are correlated.

    And then you go and contradict yourself by saying supply doesn’t affect the price.

    Reply

    MamMoTh Reply:

    @RJ,

    Good luck!

    Reply

    WARREN MOSLER Reply:

    when the fed changes the ff rate it changes the interest rate it charges the banking system when it adds needed reserves, or changes the rate it pays on reserves when there are excess reserves.

    Reply

    RJ Reply:

    @WARREN MOSLER,
    The feed has a TARGET rate – the Fed Funds Target rate. It achieves this rate by altering the supply of money via open market operations to achieve the Fed Funds effective rate. It doesn’t just decide on the rate by opening its mouth.

    http://en.wikipedia.org/wiki/Federal_funds_rate

    Reply

    Sergei Reply:

    @RJ,

    RJ: It doesn’t just decide on the rate by opening its mouth

    Check the amount of reserves in the system around any announcement day. This should be the best proof that you are wrong.

    WARREN MOSLER Reply:

    when it keeps the banks net borrowed, it just changes the cost of those funds to change fed funds rates
    when it keeps the banks net long, it just changes the rate it pays on reserve balances

    no quantity changes involved

  12. RJ Says:

    “Do regulators consider borrowed reserves as capital?”

    “Not as far as I can tell.”

    “no, liabilities/assets”

    Bank reserves are “Cash and Cash equivalents”. They are assets on the balance sheet. They carry a 0% risk weighting under Basel – i.e. they do not affect the capital ratio – which is a ratio of capital to its risk weighted assets.

    I think maybe there some confusion here between these and capital reserves which are a completely different thing.

    Reply

    RJ Reply:

    @RJ,

    Borrowing Reserves does not increase capital. Capital only increases through earnings and investor buy up of share capital.

    I think maybe some people are confused on what balance sheet capital actually is. It is NOT a pot of gold.

    Reply

    Neil Wilson Reply:

    @RJ,

    “I think maybe some people are confused on what balance sheet capital actually is. It is NOT a pot of gold.”

    It’s not a quantity restriction either.

    Capital is always available at a price.

    Reply

    RJ Reply:

    @Neil Wilson,

    No. Balance sheet capital only increases through earnings, asset revaluation, and investor buy-up of new share capital. Borrowing does not increase balance sheet capital. It cannot.

    WARREN MOSLER Reply:

    true

    WARREN MOSLER Reply:

    though gold holdings could count towards capital

    Reply

    WARREN MOSLER Reply:

    they do affect tier one capital, the overall leverage ratio.

    Reply

  13. RJ Says:

    “RJ: It doesn’t just decide on the rate by opening its mouth

    Check the amount of reserves in the system around any announcement day. This should be the best proof that you are wrong.

    Wrong in what regard? The aggregate level of reserves in the banking system is decided entirely by the Fed. No one else can put more reserves into the system.

    Reply

    Sergei Reply:

    @RJ,

    Wrong because the Fed decides on the rate simply by opening its mouth. No operations with reserves are required whenever the Fed announces a new target.

    Reply

    RJ Reply:

    @Sergei,

    Lol. Maybe you should stop before you make yourself look more of an idiot.

    http://www.federalreserve.gov/monetarypolicy/openmarket.htm

    “Open market operations–purchases and sales of U.S. Treasury and federal agency securities–are the Federal Reserve’s principal tool for implementing monetary policy. The short-term objective for open market operations is specified by the Federal Open Market Committee (FOMC). This objective can be a desired quantity of reserves or a desired price (the federal funds rate). The federal funds rate is the interest rate at which depository institutions lend balances at the Federal Reserve to other depository institutions overnight. “

    Reply

    MamMoTh Reply:

    @RJ,

    You just made yourself look like an idiot.

    Sergei Reply:

    @RJ,

    RJ, before you go too far with your claims, please take time series of reserve balances and look up what happened on any date when the Fed changed the target interest rate.

    But I wind up here. No reason to discuss anything with someone who knows everything but knows nothing.

    WARREN MOSLER Reply:

    banks do when they make loans/deposits and there are reserve requirements.
    making the loan creates both the deposit and the reserves as a matter of accounting.

    however, banks are designated agents of the fed so technically you are correct.
    ;)

    Reply

  14. RJ Says:

    “WARREN MOSLER Reply:
    May 31st, 2012 at 2:49 am

    all liabilities are also ‘instantly’ assets”

    Well, this is a truly idiotic comment. The nature of the assets change which is why a risk-weighting is applied according to the risk that the asset will not become impaired. The assets provide the cash flow. A pile of ten dollars bills has no risk. An MBS has far greater risk.

    I looked you up – are you meant to be an economist? Frankly, your knowledge and understanding is amazingly limited.

    Reply

    WARREN MOSLER Reply:

    let me rephrase to express better what was implied.
    liabilities are also ‘instantly’ assets that are subject to regulation and supervision.

    i’m just a blogger, by the way. feel free to not read this.

    Reply

  15. RJ Says:

    “RJ, before you go too far with your claims, please take time series of reserve balances and look up what happened on any date when the Fed changed the target interest rate.

    But I wind up here. No reason to discuss anything with someone who knows everything but knows nothing.”

    Mate, it seems know a darn sight more than yourself.

    “Sergei says: Well, this is a little bit away from the reality. Both from the internal risk management point of view as well as external regulations. At the very least and to my knowledge US banks are still constrained by the leverage ratio.”

    Reserves do not add to a bank leverage through the prism of regulatory capital measurement. What part of 0% risk-weighting, capital adequacy and Basel are you struggling with? What happens when you times a number by zero?

    http://www.law.cornell.edu/cfr/text/12/208/appendix-A

    “C. Risk Weights
    Attachment III contains a listing of the risk categories, a summary of the types of assets assigned to each category and the weight associated with each category, that is, 0 percent, 20 percent, 50 percent, and 100 percent. A brief explanation of the components of each category follows.
    1. Category 1: zero percent. This category includes cash (domestic and foreign) owned and held in all offices of the bank or in transit and gold bullion held in the bank’s own vaults or in another bank’s vaults on an allocated basis, to the extent it is offset by gold bullion liabilities. 29 The category also includes all direct claims (including securities, loans, and leases) on, and the portions of claims that are directly and unconditionally guaranteed by, the central governments 30 of the OECD countries and U.S. Government agencies, ”

    “Footnote(s): 30 A central government is defined to include departments and ministries, including the central bank, of the central government. The U.S. central bank includes the 12 Federal Reserve Banks”

    Reply

    MamMoTh Reply:

    @RJ,

    Clearly you don’t know any better since you are talking about something else.

    Reply

    Sergei Reply:

    @RJ,

    RJ, you clearly have no idea what you are talking about.

    To my knowledge *at*least* 2 countries in the world with large international banking systems use leverage ratio *and* capital requirements. That means capital requirements PLUS leverage ratio. Independently of each other. These countries are USA and Canada.

    The leverage ratio is calculated as Tier 1 capital / Assets and it obviously has nothing to do with risk weights or capital adequacy.

    Basel 3 has leverage ratio as part of requirements.

    Reply

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