The individual bank can use reserves to buy assets from another bank or to withdraw cash from the central bank, however, these remedies do not work for the banking system on aggregate.
The main benefit of the QE on the economy is an indirect one ie pushing mortgages rates lower which leads households to buy properties as they have the feeling to buy it cheaper. It boosts house prices, leads to spendings to refurbish the property and creates a wealth effect at least measured in terms of fiat currency. Of course the main drawback is that those who cannot or do not want play that game do not get the wealth effect and wealth gap increases... Only outlier is Japan with lower houses prices
Alfonso, the Bank of England explained QE with a different version in one of their papers, which include a pension fund.
Central bank buy T-securities from pension fund via bank; result is an assets swap in that pension fund balance sheet. Of course in perspective of bank and central bank, nothing different vs Alhambra version.
But the perspective of pension fund's asset side, they sell T-securities and now has unemployed deposit.
Central bank hopes private sector will take that deposit to buy riskier assets, or portfolio rebalance. So QE, as their explanation, does has effect on purchasing power of private sector, by forcing them to take it from the future and spend now.
Portfolio rebalancing effects are real, but please realize when the PF buys risky assets somebody has to sell. The seller now has the newly created bank reserves sitting in the banking system. Those reserves never reach the real economy.
Wouldn't it has the same effect as if i withdraw from my saving account and spend? Yes it's no new money, but instead of dead money sitting in bank account, it became circulated money?
Consider the case that pension fund buys newly issued corporate debt. PF swap their asset to riskier one, and the corporation see his balance expand with a new loan and new bank deposit
This is what I think creates a lot of the confusion, because the BOE uses a PF as an example. The problem is, there is no evidence which shows who the CB does QE with, whether it is a bank (no deposits are created), or a non-bank (a deposit is created in exchange for the asset).
If we are to assume that all QE is done with banks, then no new money for the real economy is created.
If however we are to assume some or all QE is done with non-banks, then 2 questions come to mind:
1. If a non-bank sells an asset to the CB, then we must assume it was intending to sell the asset anyway, and it is just a co-incidence that it sold it to a CB? Point here is that non-banks aren't rushing to the CB door to sell assets because a secondary market already exists (Mar 2020 an exception?) hence QE with non-banks is not adding liquidity.
2. If a non-banks does sell assets to the CB, then isn't the money it receives only going to stay in the financial sector anyway?
QE just comes across to me as a collateral drain and an income stream drain forcing the financial sector to look elsewhere
You are right. QE is just a drain of collateral in exchange for bank reserves. The CB always buys from dealers, who build inventory of bonds to sell them. This inventory can be built in bond auctions or by bidding up bond prices such that banks, insurances, PF etc sell them.
But the main point is that collateral gets drained out of the system for a very long time, and in exchange the system gets back bank reserves.
I agree that QE is just an asset swap when the central bank buys bonds from the banking system.
However, during QE, a lot of bonds were bought from pension funds and investment firms. Since the central bank can't directly buy bonds from these institutions (since these institutions don't hold bank reserves), the banks worked as intermediaries. During this process, the banks created new money (inside money) to buy the bonds from the pension funds/investment firms. After this, the central bank bought the bonds from the banks with reserves (outside money), thus executing an asset swap.
Would you agree with me that when bonds are bought from non-bank institutions, money is created?
Hi Joeri. No, I have to disagree. When CB buys bonds from a pension fund, they exchange the PF bonds for cash (let's call it cash for simplicity). This cash does not enter the real economy but rather has to be deposited overnight somewhere? Where? Well, again in the banking system.
It's basically the same as CB buying bonds from banks, with an additional step in the middle. Result is identical.
The individual bank can use reserves to buy assets from another bank or to withdraw cash from the central bank, however, these remedies do not work for the banking system on aggregate.
The main benefit of the QE on the economy is an indirect one ie pushing mortgages rates lower which leads households to buy properties as they have the feeling to buy it cheaper. It boosts house prices, leads to spendings to refurbish the property and creates a wealth effect at least measured in terms of fiat currency. Of course the main drawback is that those who cannot or do not want play that game do not get the wealth effect and wealth gap increases... Only outlier is Japan with lower houses prices
Check real rates in Japan, Eric. They can't push those down anymore. Thereby lies most of the reason on why house prices in Japan stopped going up.
Thks God I invested in France not Japan...
Love this article Alfonso - thanks. I would love to clarify something; why cannot banks use the reserves @ the CB for lending?
Alfonso, the Bank of England explained QE with a different version in one of their papers, which include a pension fund.
Central bank buy T-securities from pension fund via bank; result is an assets swap in that pension fund balance sheet. Of course in perspective of bank and central bank, nothing different vs Alhambra version.
But the perspective of pension fund's asset side, they sell T-securities and now has unemployed deposit.
Central bank hopes private sector will take that deposit to buy riskier assets, or portfolio rebalance. So QE, as their explanation, does has effect on purchasing power of private sector, by forcing them to take it from the future and spend now.
Portfolio rebalancing effects are real, but please realize when the PF buys risky assets somebody has to sell. The seller now has the newly created bank reserves sitting in the banking system. Those reserves never reach the real economy.
QE can impact the real economy only indirectly.
Wouldn't it has the same effect as if i withdraw from my saving account and spend? Yes it's no new money, but instead of dead money sitting in bank account, it became circulated money?
Consider the case that pension fund buys newly issued corporate debt. PF swap their asset to riskier one, and the corporation see his balance expand with a new loan and new bank deposit
This is what I think creates a lot of the confusion, because the BOE uses a PF as an example. The problem is, there is no evidence which shows who the CB does QE with, whether it is a bank (no deposits are created), or a non-bank (a deposit is created in exchange for the asset).
If we are to assume that all QE is done with banks, then no new money for the real economy is created.
If however we are to assume some or all QE is done with non-banks, then 2 questions come to mind:
1. If a non-bank sells an asset to the CB, then we must assume it was intending to sell the asset anyway, and it is just a co-incidence that it sold it to a CB? Point here is that non-banks aren't rushing to the CB door to sell assets because a secondary market already exists (Mar 2020 an exception?) hence QE with non-banks is not adding liquidity.
2. If a non-banks does sell assets to the CB, then isn't the money it receives only going to stay in the financial sector anyway?
QE just comes across to me as a collateral drain and an income stream drain forcing the financial sector to look elsewhere
You are right. QE is just a drain of collateral in exchange for bank reserves. The CB always buys from dealers, who build inventory of bonds to sell them. This inventory can be built in bond auctions or by bidding up bond prices such that banks, insurances, PF etc sell them.
But the main point is that collateral gets drained out of the system for a very long time, and in exchange the system gets back bank reserves.
Thank you for your article.
I agree that QE is just an asset swap when the central bank buys bonds from the banking system.
However, during QE, a lot of bonds were bought from pension funds and investment firms. Since the central bank can't directly buy bonds from these institutions (since these institutions don't hold bank reserves), the banks worked as intermediaries. During this process, the banks created new money (inside money) to buy the bonds from the pension funds/investment firms. After this, the central bank bought the bonds from the banks with reserves (outside money), thus executing an asset swap.
Would you agree with me that when bonds are bought from non-bank institutions, money is created?
Thanks!
Hi Joeri. No, I have to disagree. When CB buys bonds from a pension fund, they exchange the PF bonds for cash (let's call it cash for simplicity). This cash does not enter the real economy but rather has to be deposited overnight somewhere? Where? Well, again in the banking system.
It's basically the same as CB buying bonds from banks, with an additional step in the middle. Result is identical.