In Quantitative Easing, the Federal Reserve buys securities (typically Treasury bonds and/or mortgage-backed securities) from banks in exchange for “reserves.”
- To purchase that bond, the Fed simply credits the selling bank’s account for the agreed-upon price and debits the bond-inventory accounts the same amount.
- Credit in an account at the Fed is called “reserve” and can be withdrawn as cash.
- This chart tells what’s included in each definition of “the money supply (M1, M2, or M3). Note that checking accounts are part of the money supply but a bank’s reserves and vault cash are not.
- The Fed recently started paying a quarter of a percent interest on reserves, significantly less than the bank would have collected in interest on that bond.
- All such considerations are reflected in the price that the selling bank insists on for that bond.
- Since 2001 the money has climbed sharply to its highest level since 1959, when such records first we kept.
- At any time, anyone can sell their bonds to a bank or take out a loan against them in exchange for credit in an account at that bank, which is new money to the money supply. So it’s not surprising that the previous two rounds of quantitative easing, QE1 and QE2, have had little effect.
- Since 2008 reserves have jumped to roughly $1.6 dollars, i.e., most of the reserves that went into QE1 and QE2 are still sitting at the Fed and are not part of the money supoply. Yet another reason that QE1 and QE2 have had little effect, not even the inflation that some predicted.
In spite of the fact that I doubt that QE3 will have any effect, I welcome it because it will yet again empirically demonstrate that the government can buy up (pay off) the national debt with freshly issued money without causing hyperinflation. In other words, the alleged “debt crisis” isn’t one.