Today I was planning on a post about Quantitative Easing (QE), because it seemed to me that it would never work. However, today, Randy Wray beat me to it with another great post, this time at ND20, reviewing the whole situation in detail, placing it in political context, and explaining why it’s very unlikely that it will allow the economy to recover much more than it has already. Here are some key quotes from Randy’s piece.
. . . The Fed is in a Catch 22: Interest rate policy will not spur borrowing until economic recovery is underway, but recovery will not begin until spending picks up. Only jobs and income will stimulate spending, but the Fed cannot do anything in those areas.
This is the basic problem. Fooling with interest rates to increase business borrowing just won’t stimulate much spending in the present situation of the American economy.
No matter how mad at banks we might be, we have got to leave them with a way to return to profitability that does not rely on speculative bubbles, pump-and-dump schemes, and accounting fraud. Pushing returns on relatively safe assets toward zero is not the answer. Pumping banks full of reserves that pay very low interest will not help, either. What Bernanke might understand, but most in the mainstream media do not, is that banks do not and cannot lend reserves. Reserves are just an entry on the Fed’s balance sheet — a liability of the Fed and an asset of banks. Rather, banks make loans by accepting the IOU of the borrower and issuing a demand deposit. Only financial institutions have access to the Fed’s balance sheet, so it is literally impossible for a bank to lend out reserves.
That’s the key; QE will flood the banks with reserves. But banks can’t lend reserves. They need borrowers to lend, and they’re unlikely to get borrowers unless there’s sufficient demand out there. No one will do “if you build it, they will come,” these days.
Note that if we really wanted to use our central bank to resolve this economic crisis, it would be far better to have it directly buy houses and create jobs for the unemployed. But it makes far more sense to use our fiscal authorities for that.
But, of course, Congress and the Administration don’t want to do anything about that right now, because they are paralyzed by austerity ideology, and don’t understand that (1) the US can’t run out of money because it spends by marking up accounts, and (2) Government deficits ADD to non-Government savings dollar for dollar.
QE2 does not represent a solution to our current quagmire. No, this Titanic is still headed underwater. The sooner that the Obama administration recognizes that what we need is jobs, more jobs, and mortgage relief, the sooner we can get this ship afloat.
QE isn’t like Government spending. It doesn’t add to non-Government sector savings. What it does is SWAP cash reserves from the Fed for financial assets held by the banks. So, there’s no accretion to non-Government savings or other financial assets, and very little impact on increased business activity.
But enough of my palaver. Read Randy’s full piece, if you want a more full narrative of why QE won’t work, and want to keep it in mind when you read about Bernanke’s futile actions in the coming weeks