Why Quantitative Easing Does Not and Can Not Work

by Will on March 17, 2013


Here is an experiment which the reader may perform in the safety of his or her own home.

Take a $50 bond note issued by the US Treasury and place it on the table. Let it sit for a good few minutes so that other economic actors in the world can take note.

Now remove the bond note and immediately replace it with a freshly printed $50 Federal Reserve note, bearing the stately countenance of Ulysses Grant. Destroy the bond note.

Congratulations! You have just “increased the money supply”! Go look around the world and see if you can notice any new circulation resulting from this new $50. (Hint: nothing at all will be different).

The problem is twofold. First, a definition of “money” that includes Federal Reserve notes and excludes Treasury bonds is absurd. Bonds are nothing more or less than a special kind of money, a kind of money you use when you don’t see any better investments and want the satisfaction of a modest return in interest. It is impossible to arrive at an exhaustive definition of “money”, and for this reason, monetarism must always fail in practice. Second, the quantity of bank reserves is neither here nor there. If the idea is that banks with more reserves will lend more, it is mistaken. Banks lend as much as they are going to lend, then go find whatever reserves they need to underwrite this lending. Lending is a function of the quantity of profitable investments on the horizon, not of the quantity of reserves. Just as $50 sitting on your table doesn’t mean anything whatsoever to anyone outside your house (so long as it is sitting on your table), neither does $65 billion of new bank reserves sitting serenely in the vaults at Chase bank and Wells Fargo. Bankers are many things, but they are seldom fools. If a good investment is there to be made, they will make it. If there is not, they won’t.

The prototypical critics of Quantitative Easing have claimed it would lead to hyperinflation. I claim precisely the opposite. The problem with Quantitative Easing is that it will have no effect at all.

Now, if the Quantitative Easing program sent payments to mothers with young children, or distressed debtors, or simply paid down large student loan balances, it might be a different story. We’ll probably never know whether that would be successful. Just why is it that a so-called stabilization policy that comforts financiers is on the table, but one that would comfort less glamorous persons is not?

{ 2 comments… read them below or add one }

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