Spoiler alert: QE does not work as advertised.
The title of this Collection probably gave that away, but it bears repeating nonetheless. Why? Because of how much misunderstanding that surrounds this topic. Markets move wildly every time the words “Quantitative Easing” show up in the headlines, investors make forecasts decades out into the future based on the amounts of money QE pumps into the system; and traders see the ghost of more QE behind every poor data point and between the lines of every central banker’s statements.
For something as important to daily life as money, very few people know how it is actually created. And, no, money isn’t created via fractional reserve banking.
It is actually, literally, created from nothing.
Before we get to explaining just how such a feat is possible, we have to cover a few basics, beginning with Bank Reserves.
Ostensibly, the Reserve Requirement Ratio (RRR) was created to provide a liquidity buffer to ensure that a bank had Reserves to cover customers rushing to move their funds out of that bank, in other words, a bank run.
This is possible because banks in this day and age are theoretically “supposed” to be lending out their Reserves in order to create money in the economy.
The Fractional Reserve Banking (FRB) model is very deeply ingrained in today’s mainstream economic thinking.
This model is taught in introductory macroeconomic classes across the globe, and has been for years. Which means that every graduate, regardless of their degree, has at least heard about this if they took intro econ classes.
That’s a lot of graduates.
Modern monetary policy is based largely around Central Banks expanding/contracting the amount of Reserves in the banking system.
This is done through smaller open market operations to influence overnight interest rates for borrowing/lending Reserves, and larger operations like QE.
But this doesn’t work!
First, we need to define what is meant by QE “didn’t work”.
QE as a policy is meant to generate inflation in the economy by printing money. On the surface, this sounds simple enough, after all everyone has a pretty good notion of what “printing money” means.
Unfortunately, the only simple part of that two word phrase is the word “printing”.
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