Why QE3 Won’t Jumpstart the Economy—and What Would

The economy could use a good dose of “aggregate demand”—new spending money in the pockets of consumers—but QE3 won’t do it.  Neither will it trigger the dreaded hyperinflation.  In fact, it won’t do much at all.  There are better alternatives.

The Fed’s announcement on September 13, 2012, that it was embarking on a third round of quantitative easing has brought the “sound money” crew out in force, pumping out articles with frighting titles such as “QE3 Will Unleash’ Economic Horror’ On The Human Race.”  The Fed calls QE an asset swap, swapping Fed-created dollars for other assets on the banks’ balance sheets.  But critics call it “reckless money printing” and say it will inevitably produce hyperinflation.  Too much money will be chasing too few goods, forcing prices up and the value of the dollar down.

All this hyperventilating could have been avoided by taking a closer look at how QE works.  The money created by the Fed will go straight into bank reserve accounts, and banks can’t lend their reserves.  The money just sits there, drawing a bit of interest.  The Fed’s plan is to buy mortgage-backed securities (MBS) from the banks, but according to the Washington Post, this is not expected to be of much help to homeowners either.

Why QE3 Won’t Expand the Circulating Money Supply

In its third round of QE, the Fed says it will buy $40 billion in MBS every month for an indefinite period.  To do this, it will essentially create money from nothing, paying for its purchases by crediting the reserve accounts of the banks from which it buys them.  The banks will get the dollars and the Fed will get the MBS.  But the banks’ balance sheets will remain the same, and the circulating money supply will remain the same.

When the Fed engages in QE, it takes away something on the asset side of the bank’s balance sheet (government securities or mortgage-backed securities) and replaces it with electronically-generated dollars.  These dollars are held in the banks’ reserve accounts at the Fed.  They are “excess reserves,” which cannot be spent or lent into the economy by the banks.  They can only be lent to other banks that need reserves, or used to obtain other assets (new loans, bonds, etc.).  As Australian economist Steve Keen explains:

[R]eserves are there for settlement of accounts between banks, and for the government’s interface with the private banking sector, but not for lending from.  Banks themselves may . . . swap those assets for other forms of assets that are income-yielding, but they are not able to lend from them.

This was also explained by Prof. Scott Fullwiler, when he argued a year ago for another form of QE—the minting of some trillion dollar coins by the Treasury (he called it “QE3 Treasury Style”).  He explained why the increase in reserve balances in QE is not inflationary:

Banks can’t “do” anything with all the extra reserve balances.  Loans create deposits—reserve balances don’t finance lending or add any “fuel” to the economy.  Banks don’t lend reserve balances except in the federal funds market, and in that case the Fed always provides sufficient quantities to keep the federal funds rate at its . . . interest rate target. Widespread belief that reserve balances add “fuel” to bank lending is flawed, as I explained here over two years ago.

Since November 2008, when QE1 was first implemented, the monetary base (money created by the Fed and the government) has indeed gone up.  But the circulating money supply, M2, has not increased faster than in the previous decade, and loans have actually gone down.  (See chart below from Richard Koo, Nomura Research Institute.)

Quantitative easing has had beneficial effects on the stock market, but these have been temporary and are evidently psychological: people THINK the money supply will inflate, providing more money to invest, inflating stock prices, so investors jump in and buy.  The psychological effect eventually wears off, requiring a new round of QE to keep the game going.

That is what happened with QE1 and QE2.  They did not reduce unemployment, the alleged target; but they also did not drive up the overall price level.  The rate of price inflation has actually been lower after QE than before the program began.

Why, Then, Is the Fed Bothering to Engage in QE3?

If the Fed is doing no more than swapping bank assets, what is the point of this whole exercise?  The Fed’s professed justification is that by buying mortgage-backed securities, it will lower interest rates for homeowners and other long-term buyers.  As explained in Reuters:

Massive buying of any asset tends to push up the prices, and because of the way the bond market works, rising prices force yields [or interest rates] down. Because the Fed is buying mortgage-backed bonds, the purchases act to directly lower the cost of borrowing to buy a home. In addition, some investors, put off by the rising price of the bonds that the Fed is buying, turn to other assets, like corporate bonds – which, in turn, pushes up corporate bond prices and lowers those yields, making it cheaper for companies to borrow – and spend.

Those are the professed objectives, but politics may also play a role.  QE drives up the stock market in anticipation of an increase in the amount of money available to invest, a good political move before an election.

Commodities (oil, food and precious metals) also go up, since “hot money” floods into them.  Again, this is evidently because investors EXPECT inflation to drive commodities up, and because lowered interest rates on other investments prompt investors to look elsewhere.  There is also evidence that commodities are going up because some major market players are colluding to manipulate the price, a criminal enterprise.

The Fed does bear some responsibility for the rise in commodity prices, since it has created an expectation of inflation with QE, and it has kept interest rates low.  But the price rise has not been from flooding the economy with money.  If dollars were flooding economy, housing and wages (the largest components of the price level) would have shot up as well.  But they have remained low, and overall price increases have remained within the Fed’s 2% target range.  (See chart above.)

Some Possibilities That Might Be More Effective at Stimulating the Economy

An injection of money into the pockets of consumers would actually be good for the economy, but QE3 won’t do it.  The Fed could give production and employment a bigger boost by using its lender-of-last-resort status in more direct ways than the current version of QE.

It could make the very-low-interest loans given to banks available to state and municipal governments, or to students, or to homeowners.  It could rip up the $1.7 trillion in government securities that it already holds, lowering the national debt by that amount (as suggested a year ago by Ron Paul).  Or it could buy up a trillion dollars’ worth of securitized student debt and rip those securities up.  These moves might require some tweaking of the Federal Reserve Act, but Congress has done it before to serve the banks.

Another possibility would be the sort of “quantitative easing” first proposed by Ben Bernanke in 2002, before he was chairman of the Fed—just drop hundred dollar bills from helicopters.  (This is roughly similar to the Social Credit solution proposed by C. H. Douglas in the 1920s.)  As Martin Hutchinson observed in Money Morning:

With a U.S. population of 310 million, $31 billion per month, dropped from helicopters, would have given every American man, woman and child an extra crisp new $100 bill per month.

Yes, it would produce an extra $31 billion per month on the nominal Federal budget deficit, but the Fed would have printed the new bills, so there would have been no additional strain on the nation’s finances.

It would be much better than a new social program, because there would have been no bureaucracy involved, just bill printing and helicopter fuel.

The money would nearly all have been spent, increasing consumption by perhaps $300 billion annually, creating perhaps 3 million jobs, and reducing unemployment by almost 2%.

None of these moves would drive the economy into hyperinflation.  According to the Fed’s figures, as of July 2010, the money supply was actually $4 trillion LESS than it was in 2008.  That means that as of that date, $4 trillion more needed to be pumped into the money supply just to get the economy back to where it was before the banking crisis hit.

As the psychological boost from QE3 wears off and the “fiscal cliff” looms, perhaps Congress and the Fed will consider some of these more direct approaches to relieving the economy’s intractable doldrums.

_______

Ellen Brown is an attorney and president of the Public Banking Institute.  In Web of Debt, her latest of eleven books, she shows how a private cartel has usurped the power to create money from the people themselves, and how we the people can get it back. Her websites are http://WebofDebt.com, http://EllenBrown.com, and http://PublicBankingInstitute.org.

115 Responses

  1. […] it can deliver.Which raises the question, what is it intended to deliver?  As suggested in an earlier article here, QE3 is not likely to reduce unemployment, put money in the pockets of consumers, reflate the money […]

    • READ HOW “QE 4 The People” can not only reduce Federal Income taxes to zero and reduce FICS to Zero but also raise revenues greater that what is required for a balanced budget.
      With that being said, Mr President, Fed Chair, and Sect Treas. ,how can you not “***** “Believe nothing merely because you have been told it…But whatsoever, after due examination and analysis,you find to be kind, conducive to the good, the benefit,the welfare of all beings – that doctrine believe and cling to,and take it as your guide.”- Buddha[Gautama Siddharta] (563 – 483 BC), Hindu Prince, founder of Buddhism.
      Read,challenge,improve: http://bit.ly/MlQWNs

      • JALF – “Believe nothing merely because you have been told it…But whatsoever, after due examination and analysis,you find to be kind, conducive to the good, the benefit,the welfare of all beings – that doctrine believe and cling to,and take it as your guide.”- Buddha[Gautama Siddharta] (563 – 483 BC), Hindu Prince, founder of Buddhism.” – Amazing

  2. […] raises the question, what is it intended to deliver? As suggested in an earlier article here, QE3 is not likely to reduce unemployment, put money in the pockets of consumers, reflate the money […]

  3. […] raises the question, what is it intended to deliver?  As suggested in an earlier article here, QE3 is not likely to reduce unemployment, put money in the pockets of consumers, reflate the money […]

  4. […] raises a question, what is it dictated to deliver? As suggested in an earlier essay here, QE3 is not approaching to revoke unemployment, put income in a pockets of consumers, reflate a […]

  5. Hi Ellen,

    This is Marco Vangelisti. I met you at the Economics of Peace Conference in 2009 and I am now a founding member of the PBI. Looking forward to attending the conference in June.

    You say in your article “The money created by the Fed will go straight into bank reserve accounts, and banks can’t lend their reserves.” That is true, but an increase in the reserves of a bank, thanks to the fractional reserve system, translates into an increased ability to lend.

    QE3 seems to be transforming questionable assets on B/S of a bank into reserves which expand the bank’s ability to make additional loans and therefore expand the money supply. It seems to me that QE3 by expanding banks’ reserves is potentially inflationary, at least in the unlikely case that many more borrowers will be found to take out the additional loans made possible by the increase in reserves.

    Am I missing something?

    Thanks, Marco

    • The reason why QE3 is a great concept that could cause a total collapse is because it benefits private for profit banks (PFPB) and is a horrific weapon against “we the people”.
      IF the direction of the great plan “QE” were changed as to benefit “the people”, it could be the beginning of a path to prosperity.
      Please read: http://bit.ly/MlQWNs Read what Steve Keen has to say about “credit expansion, von Mises as to what the result of credit expansion could be, William Black has to say about banks and Michael Hudson about compound interest (excerpts are in the article). An explanation of where we went wrong with a solution to how we can fix it. Challenge it. Improve it. “

    • Marco, your understanding sounds right to me. Private spending in excess of productive capacity can be just as inflationary as public spending. But banks have been constrained by a lack of suitable borrowers, given that lending standards have generally tightened and (in the US) up to 40% of homeowners have zero or negative equity in their homes.

      If housing prices eventually rebound, given that banks are ready and waiting to lend it seems plausible that consumption will increase to accompany rising equity and consumer confidence, and the government may need to shift fiscal policy towards surplus to stem inflation. But I don’t think we’re there yet.

      • Jeff – This is my second reply.

        “and the government may need to shift fiscal policy towards surplus to stem inflation.” First of all it will be the Fed trying to stem inflation not the government. Second of all the Fed will be powerless do combat this inflation. Unless of course they are willing to implode the European and US economies. They are not, which is why massive inflation is the only possible outcome.

    • Marco, I think if you look through some of Ellen Brown’s articles you’ll find she says that banks don’t need reserves to lend. The money multiplier is defunct– there is no fractional reserve constrained lending anymore. Banks make whatever profitable loans they want and borrow reserves at cheap rates if necessary after the fact. So the QEs don’t threaten inflation by encouraging more lending. What do they do then? They bolster the stock market and other investments because they make bonds less attractive to buy,and the investment money has to be parked somewhere, or so I’ve heard. They give the banks top dollar for their MBS trash that nobody else wants. It’s welfare to the banks in that respect, but not directly inflationary.

      • Ernie – ” you’ll find she says that banks don’t need reserves to lend.” I’m not sure if Ellen said that but its not true. Try going to get your money out of an ATM when your bank has no reserves.

        • Richard, you seem to willfully misunderstand and misinterpret. The banks loan first, borrow reserves later if necessary after the fact. They are not constrained in their lending by lack of reserves. There is no money multiplier effect.

          • Hello Ernie – Let me rephrase it. Imagine time is frozen for everyone except the ATM and the depositor. There needs to be money in the ATM for the depositor to withdraw ie reserves. –

            “They are not constrained in their lending by lack of reserves. ” Agreed, but it is a risk for them to issue a loan. The risk is that depositors and borrowers will want to withdraw more cash than they have on their books at a given time. And that The Fed will pony up the dough ie The Fed trusts the bank. If The Fed says you are being reckless we dont believe these loans will be repaid there is a problem. And lets not forget there are banks which dont have The Fed as a sugar daddy.

            It is a balancing act between outstanding obligations ie cash in peoples accounts and the amount of cash they have to hand. Of course if the world moves towards an electronic currency then there will be no constraint with no risk because there will be nothing physical with which to hold them to account. Did I understand the point you were making?

  6. […] September, she said America’s economy needs “a good dose of ‘aggregate demand.’ ” It needs money put in […]

  7. […] September, she said America’s economy needs “a good dose of ‘aggregate demand.’ ” It needs money put in […]

  8. […] September, she said America’s economy needs “a good dose of ‘aggregate demand.’ ” It needs money put in […]

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