Quantitative Easing

In early 2001 Japan implemented the first instance of quantitative easing although for many years prior to 2001 the BOJ (Bank of Japan) had claimed that quantitative easing was not effective in fighting deflation and therefore had rejected its use. But in response to the liquidity crisis beginning in 2007 the United States followed suit and began QE1 which was then followed by QE2 and QE3..

Quantitative Easing - Q&A

Q: What is Quantitative Easing?

A: Quantitative Easing (Q.E.) is when the Federal Reserve buys Treasury obligations (T-Bills, T-Bonds and -Notes) from the member banks. Generally the sale is handled at an "auction" for the banks by "primary dealers" like Morgan Stanley.

Q: Is Quantitative Easing the same as "Printing Money"?

A: No. Although they are similar they have one key difference. In a normal inflationary "money printing" scenario the FED buys Treasury obligations directly from the Treasury. In so doing, it increases the money supply. Basically it is an accounting gimmick that allows the U.S. Treasury to create more debt thus expanding the money supply. But with Q.E. the debt has already been created and is already sitting on the books of the banks. So the FED takes it off the banks hands and gives them cash instead. (Actually, the FED just credits the numbers to the Bank's account, it doesn't actually move any currency). But this process just trades one type of asset (Treasury's) for another (cash deposits). It doesn't involve creating any new Treasury debt.

Q: Where does the FED get the money to pay the banks for Quantitative Easing?

A: It uses the reserves on its balance sheet. These are deposits from the member banks.

Q: So if it is just moving assets around why does the FED do it?

A: When the Treasury obligations are held by the member banks they can't be loaned out to borrowers. In a "liquidity crunch" the banks need cash not debt obligations to pay their bills and to loan to borrowers. The FED doesn't need cash so it can hold the debts and the member banks can make more loans. Theoretically, this increases money in circulation (as long as the banks actually loan the money out).

Q: Does Quantitative Easing have any effect on interest rates?

A: Yes, by buying Treasury Bills the FED is driving interest rates down. When the demand for T-Bills is up it drives the interest rates down because the bidding is based on who is willing to accept the lowest interest rate. More bidders = lower interest paid. Many other rates are affected by the lower T-bill rate so it drives all interest rates down making it cheaper to borrow money.

Q: Does the FED make money on the Treasury Bills it owns?

A: Yes, it earns interest on any T-Bills it owns just like any other T-Bill holder but according to Ray Stone, a former Fed insider and founder of Princeton based Stone McCarthy Research Associates, the FED actually returns the money to the Treasury. Last year the Fed earned about $90 billion in profits, compared with about $30 billion in years prior to the bond purchases. This benefits taxpayers by actually reducing the deficit.