Finance and capital markets
More on quantitative easing. Created by Sal Khan.
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- What if...
1. Fed prints money 500billion(assets) = 500billion(liability)
2. Fed purchases Treasuries: Mortgage Backed Securities: Corporate Bonds
Money is now stimulated into the economy.
3.The fiat money that was originally printed is now replaced with alternative assets:
500billion worth of MBS's, Treasuries and Corporate Bonds
4. New balance sheet (500BillionAsset) MBS's: Treasuries: Corporate Bonds =(500BillionLiability)
5. 3 years later... FED makes a profit on those 'investments' through interest say 200billion
6. New balance sheet : assets(700billion): liabilities(500billion)
7. 7-5 = 3
8. When the FED decides to cash in on the investments 500billion of the money is literally burnt or destroyed because it was accounted for as a liability right from the start.
9. FED makes 300billion profit
10. Inflation is dramatically reduced from skyrocketing in the next decade or so...
11. The economy can grow with a modest 2% inflation year on year with a couple of deflations here and there in about the next twenty years. Also, the lower the profit margins for the FED the better. Okay, tell me what I missed.(4 votes)
- The money going into the economy is just reserves that sit on deposit at the Fed. The money doesn't stimulate the economy unless a bank loans those funds out. If there is no demand for loans then 500 billion in reserves has entered the economy and 500 billion of bonds leave. There is no increase in assets and therefor no threat of inflation. The only thing that has changed is the make up of the assets in the economy.(8 votes)
- I've seen articles claiming the Federal Reserve is neither Federal and actually has few or even no reserves. Is their any truth to these claims?(1 vote)
- That is partly true and partly false. The way it works is that there are twelve federal reserves banks. Each of those reserve banks deals with a specific portion of the country and has its own board of directors. Six of the nine directors are chosen by the member banks, and the other three are appointed by the Board of Governors. The board of directors manages the day to day business of the Federal Reserve such as making loans and handling bank-to-bank transactions. That is the part that is clearly not federal. They also appoint the president of the regional federal reserve bank.
On the other hand, the seven members of the Board of Governors are chosen by the President, and approved by the Senate. This part, therefore, is clearly federal. The Board of Governors controls the operations of all twelve banks, and decides on both the discount rate and the reserve requirement, and it also creates regulations that all member banks must follow. The Open-Market Committee, made up of the seven governors, the president of the reserve bank of New York, and four other reserve bank presidents, basically manage the money supply. Notice, here, that even the Open-Market Committee has a majority that is appointed by Washington.
As for the reserves issue, it depends on what you call reserves. You could claim that the federal reserve banks have no reserves, because the little cash that they hold is technically not part of the money supply while it is held by the central bank. You could claim that the federal reserve banks have very few reserves, because it has very little cash and it has no reserve accounts (at itself). You can also claim that it has infinite reserves, because the reserve banks can simply create reserves on its ledgers at will. Of course, the reason it is called the Federal Reserve is because it was originally designed to carry reserves of gold, when the United States was still on the gold standard.
If you want to learn more, then I would recommend going to the Federal Reserve's website at federalreserve.gov. It explains entirely how the system operates.(3 votes)
- Sal frequently mentions that FED prints money, however only US Treasury can print money. So how is FED controlling the money supply by QE while not physically printing money? I would appreciate if one can clarify this.
- The Fed buys any currency it needs from the Treasury. It pays the cost to produce the currency, not the value of the currency. So for example maybe it pays 1c for a quarter and a few cents for a twenty dollar bill.
It really doesn't matter who does the printing. What matter is how the money is put into circulation. The Fed buys securities in exchange for dollars, and that increases the money supply.(1 vote)
- What factors does FED watch to determine when it is the time for open market option or QE? Debt/GDP ratio, pure GDP, or something else?
By my understanding, open market option happens during the normal boom-bust cycle, while the QE happens during deleveraging process. However, I don't understand how the FED determines when to do the corresponding option.(1 vote)
- Mostly they look at GDP growth and inflation
But of course they will look at whatever they think they need to look out to try to understand the outlook for those two.(0 votes)
Let's say the United States economy is going into a recession or maybe even worse than a recession. And you are the Chairman of the Federal Reserve and you need to do something about it. Well, the first thing you would do is that you would lower the federal funds rate. And that's the rate that banks lend to each other overnight. And the way that you lower it, if the banks don't do it on their own after you say you want to lower it, is that you print money as the Federal Reserve. And you use it to buy usually short-term treasury securities. And then that money gets deposited in banks. So the demand for reserves, because that's what these things are, the demand for reserves goes down, supply goes up, and the federal funds rate should go down. But what happens if you keep doing this and you keep lowering the federal funds rate all the way down so that the overnight borrowing rate is approximately 0%? What do you do then if the economy still looks like it's in a bit of a tailspin? Well you could still print money, but using that money to buy short-term debt won't help any because you're not going to lower the short-term overnight interbank interest rate anymore. So you can go out and buy other things. And those other things can be longer term treasuries or it could be other types of securities. You could buy mortgage-backed securities. You could buy commercial debt. And this idea of printing money, not just for target interest rate, but essentially, to get that money into circulation and maybe to affect other parts of the market, this is called quantitative easing. And in Bernanke's mind, although that's exactly what he's doing, he's printing money to buy other things than what the Fed traditionally does when he cares about the overnight borrowing rate, he calls it, not necessary quantitative easing, but credit easing. And in his mind, even though mechanically they are the same thing, in his mind, he saying, look, I'm printing this money not just for the sake of printing the money and putting it into circulation, I'm printing money so that I can buy particular assets where it seems like there might be a log jam in the credit markets. Because with just printing money and buying government securities, maybe the interest rates on government debt goes down, but maybe because of panic or crisis, interest or the prices on these things don't behave properly. So in order to fix that, credit easing, in the Bernanke sense, would be to go out and buy this type of asset.