Um, Just What The Heck Is Quantitative Easing And Why Are We Doing It?

There’s been a lot of talk over the last few days about “quantitative easing,” but if you’re wondering what it is and why it matters — you’re not alone. Long story short — it’s a way for the Fed to create money out of thin air.

There are several ways to increase the amount of money circulating in the economy. You can spend it (stimulus package), you can cut interest rates (interest rates are now basically zero), or, after you’ve done all that, you can bust out the quantitative easing.

We’ve done it before — back in 2008, and now the Fed is expected to try it again. It’s a strategy they borrowed from Japan… where it didn’t seem to fix anything. But, never mind that, here’s how it works:

1) A bank has something they don’t want to sell because nobody is paying enough.

2) The Fed is like, hey, how about we buy that off you for a little bit more than market price.

3) The bank is like, yeah cool.

4) The Fed credits the bank’s account with money that it creates.

The idea is that the bank will then put that money out into the economy where people can benefit from it.

Like most of economics, nobody actually knows if this works and talking about it makes people angry. So why are they thinking about doing it again? Well, the consensus seems to be that they’ve tried everything else.

Fed may try quantitative easing to boost economy [Marketplace]
Quantitative Easing Explained [NPR]
Dollar Gains on Speculation Fed Will Limit Quantitative Easing [Bloomberg]
What Is Quantitative Easing? [Consumerist]
US Stocks Fall As Investors Lower Expectations Of Fed Easing [Wall Street Journal]

Comments

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  1. SonarTech52 says:

    So what happens to all the stuff that the Fed bought?

    • Alvis says:

      The US is too big to fail, so China will bail us out.

    • crazydavythe1st says:

      Presumably the Fed waits to sell the stuff, much like the bank would have. The Fed probably then destroys the cash it generates from the sell.

      It basically seems like a trick to get banks to increase lending.

    • amadaden says:

      The normal way to do this is with Govt bonds. So in that case after X years the buyers collect there money.

    • Megalomania says:

      The main thing that is bought via quantitative easing is… government bonds. So the government pays out money now that it would have paid out later, essentially paying back the bonds.

  2. nova3930 says:

    Oh yeah, print more money ASAP. That way when we do finally claw our way out of this hole, inflation will go absolutely NUTS. I can’t wait till a gallon of milk costs a cool Benjamin….

    • DH405 says:

      Hey, it’d make paying your debts off really easy at least.

    • johnva says:

      Deflation is a much bigger threat right now.

      • evnmorlo says:

        Yeah, with most commodities increasing by a third in a few months deflation is imminent.

      • amadaden says:

        Bingo. Ever since TARP people have been saying how QE would send us in to run away inflation. It has not happened in the last two rounds of QE and would be very very unlikely to happen if a new one is tried.

        BTW Anyone interested in why this would work should start reading Paul Krugman (http://topics.nytimes.com/top/opinion/editorialsandoped/oped/columnists/paulkrugman/index.html). He does a great job of explaining why QE is a good idea, will work, and how Japan actually did not do it for the longest time.

        • nova3930 says:

          Sorry but I’ve read enough from avowed Keynsians like Krugman to know they’ve lost their collective minds. The idea that simply blowing as much money as possible through the system will cure all our economic woes is simply ludicrous on the surface, never mind the practical considerations.

          Take the stimulus. Krugman argued is should have been bigger. Well how much bigger? No real answer to speak of. So lets assume for arguments sake that fiscal stimulus effects scale linearly. If you extrapolate out the cost/effect curve based on the recent stimulus package, we would have to borrow and spend the entire US GDP to “get the economy back on track.”

          Now that assumes a linear relationship, there could be multiplicative effects but more than likely due to crowding effects there will be a plateau of the curve on the upper end, reducing the effects of any stimulus of that size. The best available studies have shown that the best “bang for your buck” in stimulus is in defense spending and even that only as a multiplier of 0.9.

        • DoctorMD says:

          Have you looked at commodity prices? Up 25-125% across the board. True measures of the cost of living are up 6-23% this year. The “Core – Completely Pointless Indicator (CPI)” is not elevated. I guess its OK if you don’t spend any money on energy, food, education, medical care, or housing.

          • doctor.mike says:

            Are you sure about that? Obama said that we social security recipients had no need for cost of living allowance for the second year in a row. I guess they don’t eat in the White House. Plain white potatoes in New York city: One year ago 20 cents per pound. Yesterday at a major supermarket, $1.50 per pound.

          • amadaden says:

            Krugman has an explanation for that as well.
            http://krugman.blogs.nytimes.com/2010/10/23/the-worst-economist-in-the-world/

            I’m not an economist but I’ve been reading Krugman for the past 2 years and have found all of his predictions to have come true unlike the predictions of others who claimed that the stimulus would cause endless inflation.

  3. c!tizen says:

    Dude, government… WTF?

  4. Buckus says:

    “I really needed that $100. It would have bought me ONE GALLON OF GAS

  5. milty456 says:

    They haven’t tried giving money directly to the people yet? They gave a ton of it to corporate america and the banks…and they kept it all…if they want money to get to the people, why not try the obvious…give it to them

    • Buckus says:

      They did that in 2001. Maybe this time around they’ll consider a cool grand.

    • johnva says:

      They did. Many of us got an $800 tax cut this year.

      • milty456 says:

        Yeah wasn’t it like $14 dollars per paycheck or something…I’ll take what the other guys got….a few hundred billion.

        • nova3930 says:

          Yep, the wife and I are living high on the hog with the extra trip to MickyDs we can afford every month now….

          • johnva says:

            The point of the stimulus funds isn’t to help you live high on the hog. It’s to make the economy function better again. And if you spent your tax cut at McDonald’s every month, you would be doing exactly that…reinjecting it into the economy and providing someone with a job.

            • kenskreations says:

              Only thing is did it work? So far, I have only seen AIG waste the taxpayers money, BoA waste the taxpayers money and when I worked, less sales and fewer hours. This means less income for my family and less spending. Sorry but I think it has been a failure for the taxpayers now and in the future. Yes GM is saved. But look at the unemployment that caused. Not only the people that worked there, but also the people that were employed at dealerships and the people that were employed at the other supply places.

              • johnva says:

                This post is kind of incoherent. You’re complaining about people associated with GM losing their jobs, and saying that’s the fault of the stimulus? More of them would have lost their jobs if the government hadn’t intervened.

                Yes, the stimulus has worked. There is strong evidence that it did. There is also strong evidence that it wasn’t big enough. When you have a recession of this magnitude, it’s very hard for government to turn things around quickly. But there has been a lot of job creation since the stimulus funds really started kicking in. State governments have been laying people off in droves, however, which counterbalances a lot of that. Again, that’s the not the fault of the stimulus given that the stimulus tried to counteract that as well by giving financial assistance to the states and stalling their layoffs for awhile.

                It may not be emotionally satisfying to you to not view this as an all-or-nothing, it worked or it didn’t type of thing, but it’s true. It would have been much worse if the stimulus spending hadn’t been done.

                Also, don’t confuse the stimulus (passed under Obama) and TARP (which was the bank bailout bill passed under Bush). They are two completely different things.

        • johnva says:

          YOU personally wouldn’t be getting all those billions. If that were divided up, your share would not be all that much more than what you get through the tax credit they did create. And the point of giving it to people gradually through a withholding adjustment was so that people would be more likely to spend it, thus stimulating the economy and jobs growth. When they just write people a big check or give them a bigger tax refund, many more people save it, and thus the economy does not benefit as much immediately. Unfortunately, because it’s so spread out, most of the idiots in this country aren’t even aware that they got a tax cut because of Obama’s policies.

          Regardless, my original point was the government DID just give all us regular folks money as part of the economic stimulus. And I’m correct on that point. You can argue that perhaps more of the money should have been directed to normal people (personally, I think it would have been a good idea for them to just write everyone a big check that could have gone to pay down mortages, student loans, etc, so that the debt would be wiped off the books AND the banks would be made solvent again)…but again, measures like that were opposed by the conservative side of the aisle who were eager to try to demonize homeowners as greedy while falling all over themselves to bail out the banks.

      • homethinking says:

        I believe that the ‘tax cut’ we got was just a reduction in witholding…being called a tax cut.

        • johnva says:

          Wrong. It’s an actual tax credit…the only confusion some people have is that they also adjusted the withholding tables so that you get it gradually in the form of a slightly higher paycheck each time. But your actual tax liability is reduced because of it…it’s a genuine tax credit.

    • Cheap Sniveler: Sponsored by JustAnswer.comâ„¢ says:

      Hey, Obama promised us “change.”

    • craptastico says:

      Bush had done that twice in the past

    • dragonfire81 says:

      For the curious, 750 Billion (the approximate size of the Obama stimulus package) divided by 380 million (the approximate population of the U.S.) works out to $2000 per person in this country.

      • craptastico says:

        exactly. 2k per person isn’t going to help someone who’s underwater and unable to make their mortgage payments. it’ll just be one more payment to the bank before foreclosure or bankruptcy

        • Conformist138 says:

          Fine, ok, so it won’t be helping people facing foreclosure. but you know what: I’m tired of waiting in line! I’m broke, i can barely pay my own bills, it’s to a point where i’m just *barely* getting by each month… but i don’t own anything of value, so no one cares. i have a job, so they say i’m fine. i can’t get health care, i can’t see a dentist or get new glasses, i can’t pay off my smaller student loans… $2,000 would actually do a TON for me and I’d spend it at businesses that otherwise wont see a dime from me.

          speak for yourself, but i’m poor enough that $2k would be a major relief.

          • craptastico says:

            than you must have loved GWBush. he sent us checks for $400 a couple of times. he paid something like $400 to singles and $800 to married couples.

  6. JoeS says:

    Will this address the problem of banks sitting on their money, or using it to give executives bonuses? At least if the banks have a surplus of money, they’ll presumably try to invest it or make loans to someone who will use it productively. More money circulating should boost the economy. Look at the bright side–if you have a mortgage or own stock, your value will appreciate if there is inflation from creating too much money.

    • crazydavythe1st says:

      The whole concept of inflation suggests that there is a devaluation in the real value of currency. It won’t help your stock portfolio or your mortgage because in essence any gains you make there will be offset overall higher prices.

      • Necoras says:

        Not exactly. More money circulating means that a dollar today is worth less than it was yesterday.
        An example:

        Say that there are $1000 in our economy. I’ve borrowed $500 from you to start a business. I’m making $100 a year, and paying you $50 of that to pay off my debt. Assuming no interest, it will take me 10 years to pay off that debt. Now, the money gods determine that the economy isn’t doing so great, so they create another $1000. I’m now able to make $200 every year, because there’s more money to go around and more people are buying my widgets. That means that I can now pay you $100 every year, and pay off my debt in 5 years. This is great for me (the borrower); I’ve paid off my debt in half the time doing the same amount of work. That is, I’ve created no more value, but I am out of debt twice as fast.

        However, this is terrible for you (the lender). You’ve been paid your $500, but it’s only worth half of what it was when you lent it out. This, by extension is terrible for anyone who has invested with you. Their investment is worth half of what it was before the extra $1000 was poofed into existence.

        All of this is a way of saying that Quantitative Easing is great for the mortgage payer (borrower) because it’s easier to pay off the loan. It’s terrible for the bank (and all of its investors; that is, your stock portfolio) because the money they’re getting paid for the loan is worth less than it was when they made the loan.

        Forced inflation by printing money *always* favors someone who is in debt, and punishes someone with savings. Since the US government is one of the biggest debtors there is, expect to see more of this.

  7. Plasmafox says:

    So… the government is buying toxic assets from banks.

    This can’t end well.

    • johnva says:

      TARP ended pretty well.

    • craptastico says:

      they’re actually buying mostly US Treasury bonds. now that i think about it you might be right about them being toxic (i certainly wouldn’t lend our gov’t for 30 years at 4%)

  8. two_handed_economist says:

    QE is simple:

    The Fed buys US Treasury bonds from banks. The banks can then lend out money to borrowers.

  9. ARP says:

    So, the banks can give themselves even bigger bonuses and sit on even more cash (i.e. more than they need to maintain appropriate reserves)? What could go wrong?

    • Bativac says:

      Yeah, I don’t see how this creates any incentive for struggling banks to just turn around and lend out the cash, knowing they may never see it again and might eventually have to sell the debt to a collector for pennies on the dollar.

      I think the problem is things are just going to suck for awhile. Sometimes stuff just sucks and you can’t really fix it.

      • Danny Boy says:

        It doesn’t encourage banks to lend money. Banks simply hoard the cash and that’s all they’ll do this time. The government is attempting to get the banks to loan money to small busniess….but it just doesn’t happen.

    • two_handed_economist says:

      Banks sitting on the cash is not the worst that could happen. At least that wouldn’t be throwing away money.

      And it seems to me that won’t really happen for very long, as the bonuses for selling assets slightly above market and holding cash reserves aren’t that great, so the incentive among bankers is to do something with the cash.

      That’s where it could get bad, because actually the worst thing that could happen is another misallocation of capital — like that which supported the mortgage craze — in which bankers will put a substantial amount of the available loanable funds into the hands of people who can’t do anything productive with it, and have no chance of repaying on any terms.

  10. lucky13 says:

    So last time they tried printing more money and giving it to the banks, who just kept it for themselves instead of loaning it out to small businesses and citizens.

    Apparently, that worked so well that they are now willing to print more money so they can buy “stuff” at above market value from banks who will just keep it for themselves again.

    Only in DC would this even begin to make any sense! Any wonder why people are angry about the blind leading the blind (economists & politcians) in a vicious circle of fail?

  11. ndonahue says:

    OK, no one knows it it’ll work, and we can say is didn’t work in a completely different time and context (Japan), but I can’t see the downside. If someone can point it out the downside (preferably someone who knows a bit about macroeconomics), I’d appreciate an explanation.

    With fed lending rates 0% and a risk of deflation stalling increased production, why not use “printed money” to buy back a bunch of government debt? In the best case, this spurs lending and increased economic output. In the worse possible case, we’ll see inflation, which can then be controlled by increasing interest rates. Either way, the government reduces total debt and future debt payments. Who loses here?

    • nova3930 says:

      If your gov’t isn’t actively borrowing money it works pretty much like you described. The problem comes in when a gov’t, like ours currently, is continually borrowing more and more money.

      See, investors aren’t stupid, and they’ll quickly catch on to the fact that the central bank is running the printing presses non-stop in an attempt to devalue debt away. At that point, they’ll start demanding higher and higher interest rates for the money they lend to the gov’t.

      At best, long term, your debt payments stay the same and more likely they go up due to the increased risk of default that rapid currency devaluation entails ie typically the countries that rapidly devalue their currency are the ones that have no hope of ever paying their debts back, think Zimbabwe….

      • ndonahue says:

        That makes perfect sense. Thanks.

        A bit of a slippery slope. The Fed wants to target buy-backs to domestic debt holders, but that’ll piss off the sovereign debt holders (like China).

        It was all so much easier when we traded beads for shells…

        • jamar0303 says:

          China’s already making a fuss because they’re still linked to the US$. But they’re already seeing inflation associated with their rapid growth. So this makes it worse. Their only way out is to unpeg… Which is what the US has been pushing for all along. Hey, I see something there.

          • RvLeshrac says:

            The amusing part is that if the Yuan was unpegged, we’d be paying $100 for plain white T-shirts – partially due to the increased cost to import them from China, and partially due to the fact that most of the US textile mills have been closed for years.

  12. jsl4980 says:

    The best analogy I’ve heard for it is: imagine you run a pet rock company, and no one wants to buy your pet rocks. Quantitative easing is similar to taking out a loan to purchase your own inventory of pet rocks in hopes of creating more demand for pet rocks.

  13. Eyegor says:

    Oh wait…. I know…

    What about stop spending money they don’t have on silly crap like Cash for Clunkers. Or maybe they can spend it on a copy of “The Road To Serfdom” by Hayek for everyone in the country.

  14. erratapage says:

    The theory is that you aren’t creating more money, because it’s an exchange of goods for money at a not much more than fair market price. To work, the purchase itself must create a new price for the item in the near distance future, and be within spitting distance of the current inflation rate. There are a few risks associated with the strategy. 1) the Fed could be the new owners of poorly valued securities or real property (and given the recent stories about fraud, this is a very real threat). In this case, the Fed becomes the holders of the risk associated with the strategy, which is likely to lead to destabilization, more than merely inflation or deflation. 2) the purchase of the securities or real property could lead to artificial scarcity, as the Fed holds onto the asset longer than a bank would have. This is likely to lead to specific price inflation, which might be a good thing with respect to housing.

    So, the extra cash in the economy may ease up lending, and the method to increase the cash flow may lead to scarcity and price increases. If it works, great! However, if the banks just convert the Fed money to profits and don’t ease up on lending, we’re sunk.

  15. Nessiah says:

    if only scrooge mcduck were real. he’d know what to do!

  16. Cheap Sniveler: Sponsored by JustAnswer.comâ„¢ says:

    “The idea is that the bank will then put that money out into the economy where people can benefit from it. “

    Wha? The banks aren’t exactly giving out cash these days, they’ll just sit on it. Maybe use it for a nice corporate get to gether, but lend it out? Not happening.

  17. Cheap Sniveler: Sponsored by JustAnswer.comâ„¢ says:

    “We’ve tried everything else”.

    Not really, there IS another option. I’m going to suggest the government do something really radical here:

    “Don’t Buy Stuff You Can Not Afford” http://consumerist.com/2010/10/snl-teaches-the-secret-to-staying-debt-free.html

  18. OnePumpChump says:

    “The idea is that the bank will then put that money out into the economy where people can benefit from it.”

    I think I see the problem here.

  19. NumberSix says:

    So basically the prime rate is now negative. The Fed is paying banks to take their money.

    • amadaden says:

      Kinda. Lower the prime rate and inflation speeds up, raise the prime rate and inflation slows down. The job of the Federal Reserve is to keep inflation low and steady because that’s the sweet spot. At the moment we have a prime rate at zero and we still have low inflation that is getting even lower because the economy is a mess. This might result in DEflation and that is a really bad problem because the economy then grinds to a halt.

      So yeah, QE lets you lower the prime rate below zero.

  20. peebozi says:

    why wouldn’t a bank take the free cash they’re getting from the fed and CONTINUE buying US guaranteed Bonds that will pay the 2% interest?!?!

    they get 1,000,000,000 from the government and “invest” in treasuries that are guaranteed to 2% a year….that would be $20,000,000 in interest income. and that’s if the gov gives them ONLY one billion.

    biggest scam going….ever. fucking crooks should be exiled.

  21. NydiaGeben says:

    More madness from the Fed. Marvelous. Simply Marvelous.

  22. DJSeanMac says:

    Every incentive we’ve offered the banking industry has failed to yield results for anyone other than the bank itself. I say it’s time to start talking increased regulation. We’ve tried the carrots, so it’s time to tell bank execs to go in the back yard and pick a switch for their whoopin’.

  23. donovanr says:

    Why give the money to banks? They are the bozos who got us into all this trouble. If you are giving it away give it to taxpayers who will not only spend it but spend it in America? Or give it to American factories who can then compete with China.
    I can think of a thousand sets of people who would be better than banks. Street bums would be better than banks, literally.

  24. notthere56 says:

    Most money is created out of thin air already. If you haven’t seen the video Money As Debt, you need to: http://moneyasdebt.net/ While we’re at it, why don’t we talk about who/what the Federal Reserve is? Hint: there’s nothing federal about it. We can only fix the problem if we know what it is, and the deficit is not.

  25. Duckula22 says:

    Give that money to me and I’ll put it back into the economy right away.

  26. kenskreations says:

    Reply to Dragonfire81 and Johnva: $2000 in my pocket will allow me to go and spend it which would help the economy better than letting the insurance companies, banks and large business get the money and giving it to their large income people. It has been and will always be the little person that are paying the most for living. He/she is the backbone of this country and by giving them the $2000 when they make only $20,000 a year, amounts to be a 10% raise. But to someone who makes $200,000 it’s only a 1% raise. Since these people are the ones that suffer, give them the money. The taxpayers are to only ones that pay “thru the nose”. We pay taxes, we purchase items and we are the ones who work for it. If a company pays more taxes, we the taxpayers (consumers) are the ones that pay it because prices go up. We need to focus more on helping the people then helping the companies (AIG, BoA). Just look at what they did with the money when they got it. The big bonuses and lavish spending all at the expense of the taxpayers. Sorry that I didn’t get the $800 last year. I only got a little over $5 a week ($260+) for the whole year. And no pay raise from the company because of slow business. And expenses got more while my hours last year dropped. Working 4 six hour days did not reduce expenses (I used to work 4 ten hour days). I still had to drive in 4 days a week. Now on SS and with no raise this year because the CPI didn’t go up (sure). But our government is spending more now then ever before and (my opinion among others) we are getting less. Remember the new hiring by the federal government just after President Obama was sworn in? How about their 5% raises (I have read it cost the taxpayers $30 billion for this). Sorry if this sounds like complaining, but just stating what it feels like to be at the lower end of the pay scale.

    • johnva says:

      I’m not against giving more assistance to working people, and in fact all of my policy preferences have been oriented towards that. President Obama’s have as well, for the most part. But he has to work with conservatives in Congress who don’t agree with that philosophy, and tax cuts were part of the “price” for the stimulus.

      TARP (under Bush) was for the banks. The stimulus (under Obama) was to help the larger economy. Both have been fairly successful, but not enough, because the economy can’t just magically be turned around when government waves its wand. We have a lot of more fundamental problems caused by wealth inequality and an increasing lack of international competitiveness in some industries, and that can’t be fixed overnight.

      I too wish more assistance had been given to working people, over the tax cut that many people received. But the problem was that the economy needed help in a LOT of different areas, and it was politically toxic to make the stimulus even bigger than it already was. Lots of people hate the idea of bailing out the banks, but in my opinion it was a necessary evil in that our entire economy would collapse if they had all gone down in a chain reaction. It pisses me off, and the bailouts should have been coupled to MUCH heavier regulation of the banks in order to prevent them from trying the same thing again, but this is what we could get in a political environment where one of the major parties in Congress hates all regulation or assistance for regular people and filibusters everything they disagree with.

      And again, spreading out the tax cut helps the economy more, because it encourages people to spend it.

  27. grumpygirl says:

    Thank you. At this point, if they decided to line up all the Keynesians against the wall, I would not object.

    The think about Keynesian economics to keep in mind is that the whole concept only works (per Keynes himself) if debt is paid down in times of prosperity and a country goes into a recession with little to zero debt. Too bad we didn’t do that in the US and it’s really too bad that people believe all that hocus-pocus is going to work with our national debt being where it is. Sooner or later, China is going to take away our credit card. I really, really don’t want to be around for that.

    • johnva says:

      I agree that debt should be paid down when times are good. Unfortunately, the Republicans would rather give tax cuts to the rich than actually pay the debts that have been run up.