Great Leap Forward


It is “QE Week” at EconoMonitor and here’s my contribution.

No, we aren’t celebrating either the Monarch or the ship. We’re talking about the Fed’s Quantitative Easing. I’m going to discuss the basics of QE and explain why it’s Much Ado about almost Nothing.

  • This past September the Fed announced full speed ahead with QE3. Three’s a charm, or so they hope. This time, the Fed promised to buy $40 billion worth of mortgage backed securities (MBSs) every month through the end of the year, and to keep what is essentially a zero interest policy (ZIRP) in place through mid 2015. The Fed also announced that it will purchase other long-maturity assets to bring the total monthly purchases up to $85 billion, with the bias toward the long end expected to put downward pressure on long term interest rates. The Fed made clear that QE3 is open-ended, to continue as long as necessary to stimulate to a robust economic recovery.

    There are two reasons why economic stimulus has come down to reliance on the Fed’s QE. First, policy-makers have bought the Austerian view that fiscal policy is out-of-bounds; some believe it doesn’t work, others believe government has “run out of money”. Both of those views are pure nonsense, but beyond the scope of this blog.

    The second reason is that Chairman Bernanke is enamored with the view that proper monetary policy could have avoided the American Great Depression as well as the Japanese lost decade(s)—two and counting. Essentially, he staked his academic career on the argument that there’s more that the central bank can do, beyond pushing its overnight rate (fed funds rate in the US) to zero (ZIRP).

    When the crisis hit the US in 2007, Bernanke followed the Japanese example by quickly relaxing monetary policy, rapidly pushing down the policy interest rate. After some fumbling around, the Fed also gradually opened its discount window to lend an unprecedented amount of reserves to troubled institutions. As I’ve discussed in previous blogs, all told the Fed spent and lent a cumulative total of $29 trillion to rescue the banks.

    And the Fed’s balance sheet literally exploded—which has got our quantity theory Monetarists and Austrians and Ron Paul followers hyperventilating about hyperinflation. The following graph documents the spectacular growth of the Fed’s liabilities, most of which are “deposits”, that is bank reserves. (See here for discussion:

    But that didn’t put the economy on the road to recovery. (Surprise, surprise! Bailing out Wall Street doesn’t help Main Street.)

    And so the Chairman got the chance to try out his pet theory. The Fed should go beyond ZIRP to try unconventional policy, namely, it should continue to buy assets even after it had driven short term interest rates to the zero lower bound. Over the course of the three rounds of Quantitative Easing the Fed has bought prodigious amounts of Treasuries and MBSs.  The following graph shows what the Fed bought. (For detailed explanation, and a key to the abbreviations, see here:


    When the Fed buys assets, it purchases them by crediting banks with reserves. So the result of QE is that the Fed’s balance sheet grows rapidly—to, literally, trillions of dollars. At the same time, banks exchange the assets they are selling (the Treasuries and MBSs that the Fed is buying) for credits to their reserves held at the Fed. Normally, banks try to minimize reserve holdings—to what they need to cover payments clearing (banks clear accounts with one another using reserves) as well as Fed-imposed required reserve ratios. With QE, the banks have ended up with humongous quantities of excess reserves.

    As we said, normally banks would not hold excess reserves voluntarily—reserves used to earn zero, so banks would try to lend them out in the fed funds market (to other banks). But in the ZIRP environment, they can’t get any return on lending reserves. Further, the Fed switched policy in the aftermath of the crisis so that it now pays a small, positive return on reserves. So the banks are holding the excess reserves and the Fed credits them with a bit of interest. They aren’t thrilled with that but there’s nothing they can do: the Fed offers them a price they cannot refuse on the Treasuries and MBSs it wants to buy, and they get stuck with the reserves.

    A lot of people—including policy makers—exhort the banks to “lend out the reserves” on the notion that this would “get the economy going”. There are two problems with that. First, banks can lend reserves only to other banks—and all the other banks have exactly the same problem: too many reserves. A bank cannot lend reserves to your household or firm. You do not have an account at the Fed, so there is no operational maneuver that would allow you to borrow the reserves (when a bank lends reserves to another bank, the Fed debits the lending bank’s reserves and credits the borrowing bank’s reserves). Unless you are a bank, you cannot borrow them.

    The second problem is that banks don’t need reserves in order to lend. What they need is good, willing, and credit-worthy borrowers. That is what is sadly lacking. Those who are credit-worthy are not willing; those who are willing are mostly not credit-worthy.

    And we should be glad that banks are not currently lending to the uncredit-worthy. Here’s why: that’s what got us into this mess in the first place.

    Indeed, the mountain of debt that US households are buried under makes the whole Bernanke notion that we need to get banks lending again just plain ludicrous. I don’t want banks to lend. I don’t want households to borrow. What we need is to work off the private debt—pay it down or default on it.

    Some believe that the path to recovery is to get firms to borrow. Again, I think that is wrong-headed. Firms are actually wallowing in cash—they’ve cut costs, fired workers, and stopped spending in order to shore up their cash reserves. They don’t need banks. Indeed, they mostly stopped using banks to finance their spending a long time ago, as they shifted to commercial paper and other nonbank funding.

    Yes, I know that the story is different for small firms—they don’t have cash flow and they aren’t considered credit-worthy so they cannot borrow. They are in a sense collateral damage—Wall Street screwed the economy and households and small business are paying the price. The solution is not more debt for them. If anything, small firms need to do the same thing that most households need to do: reduce debt.

    So, we’ve got banks that don’t want to lend and households and small firms that shouldn’t borrow. We’ve got bigger firms hoarding cash. We have what Richard Koo calls a “balance sheet recession”: too much debt and a strong incentive to de-lever. Firms and households are not only cutting spending, they are also trying to sell assets to pay back debt. And so asset prices are falling.

    All the more reason why banks don’t want to lend. The assets that could serve as collateral are falling in value.

    Is there a way out? Yes there is. There is only one entity in the US that can spend more in a balance sheet recession: Uncle Sam. But Washington won’t let Sam do it. And so we will not recover.

    That is the lesson Chairman Bernanke should have learned from Japan: if you don’t ramp up the fiscal stimulus, and keep it ramped up until a full blown recovery has occurred, you will remain trapped in recession.

    To be sure, it is not Bernanke’s fault that Washington won’t spend more. He’s not in the White House; he’s not in the Treasury; and he’s not in Congress. He has nothing to do with fiscal policy. He’s playing with the only hand he was dealt: monetary policy. And in a balance sheet recession, that hand is impotent.

    So at most, the Chairman is guilty only of creating irrational expectations. He’s the Wizard of Oz, but that steering wheel he’s spinning is not attached to the economy.

    What QE comes down to, really, is a substitution of reserve deposits at the Fed in place of Treasuries and MBSs on the asset side of banks. In the case of Fed purchases of Treasuries, this reduces bank interest income—making them less profitable. Some held out the unjustifiable hope that less profits for banks would equate to more inducement to increase lending. Won’t work, and a bad idea even if it did.

    We want banks to make good loans to willing and credit-worthy borrowers. We don’t want to make banks so desperate for profits that they make crazy loans (again!).

    On the other hand there could be some benefits to banks that manage to unload trashy MBSs by selling them to the Fed. If you were a bank that was stuffed full of all the NINJA mortgages (no income, no job, no assets) made back in 2006, you’d be quite willing to sell those to the Fed—if the Chairman wants to play the role of dope, you’ll happily dupe him. I suspect that as a result of the bail-out plus three rounds of QE, a lot of the trash has been moved to the Fed’s balance sheet.

    That’s good for banksters but it’s horrible public policy. Effectively the banks are moving sure losers off their balance sheets in order to get safe reserves that earn next to nothing. That’s a good trade! But, again, it doesn’t induce them to make more loans, does nothing to stimulate Main Street, and creates all sorts of moral hazard in the financial system. Uncle Ben has taught banks an invaluable lesson: too dumb to fail!

    Let’s summarize QE this way. You have a checking account and a saving account at your bank. Your bank makes you an offer you cannot refuse to shift some funds from your saving account to your checking account. (Let us say they will give you a toaster as a reward—and you really like toasted bread.) Will this shift of funds induce you to run out and spend more? Probably not. Especially if you are worried about the future, your spouse was recently fired, and you are underwater in your mortgage. You might even spend a bit less because you earn less on interest in the checking account.

    QE essentially amounts to shifting funds from a bank’s saving account at the Fed (Treasuries) to its checking account at the Fed (Reserves). It reduces bank earnings by a hundred or two basis points.

    And that is supposed to simulate the economy?



    Charley ClarkNovember 12th, 2012 at 7:25 pm

    I know this iuggestion is the result of past drug use, but can the Fed start forgiving or writing down the various mortgages in the vast MBS they own? This could help reduce debt levels.

    And is the Fed is paying full value?

    Charley Clark

    interested readerNovember 12th, 2012 at 8:14 pm

    regarding fiscal stimulus: Japan ran an average deficit of over 5% since the early 1990s with peaks at 10% or so (same in primary/structural deficit terms) and has accordingly run up a scary public debt ratio. What is an adequate fiscal stimulus?

    Ronald L.November 12th, 2012 at 9:02 pm

    Excellent article! I've always struggled to understand how the FED is trying to overcome the crisis by rewarding banks' bad lending and investing decisions, with the ultimate goal to get them to lend more money again and return to the pre-crisis era of reckless lending to credit-unworthy borrowers.

    EugenRNovember 12th, 2012 at 9:52 pm

    1. The legal reserve requirements in US is 10%, but since the banks have no more “AAA” clients like, Greece, Spain, sub-prime mortgages, AIG, General Motors, Enron, et.c., the banks have no one to whom to borrow. So they keep it in the Fed reserve.

    2. In my sketch article;

    I collected some interesting data as to 12.2011, (Most of it published in CIA world book). The total US national debt is 15 trillion, out of it the public debt (Government securities) 10 trillion, the difference is between non-marketable and marketable securities. The non marketable are liabilities, but have only marginal impact on the current economy, so we can leave them where they are. Out of the marketable about 5 trillion are hold by foreigners amazingly as reserves. Most of the remaining is probably hold by long term funds, like pension funds etc. It is after all not surprising at all, that so little Government securities are held by general public, since their saving rate is already years close to zero. At the end of the day, the public debt seems surprisingly healthy, until the foreigners are ready to hold their reserves in US dollars.


    The MB is the reserve of commercial banks deposited in the Federal bank, and it grew roughly between 2008-2012 from 1 trillion to 2.5 trillion, and the M2 in the same period from about 8 to 10 trillion.

    The M1 did not change much during this time. The monetary ease obviously doesn’t work. Why is it so? Because of luck of business opportunities. Real estate shrinks. Wall street is not what it used to be, nobody trusts anymore nicely warped mortgage packages.

    Is any exit from here? Only to roll up the sleeves and start to compete the Asians.

    olly100November 12th, 2012 at 10:24 pm

    I think the main 'transmission mechanism' was supposed to be through "portfolio rebalancing".

    The Fed hasn't only bought Treasuries and MBS from banks – it's bought them from loads of non-bank people too.

    For example, if you previously had some Treasury bonds, after QE you just have a big deposit sitting in your bank account. Because it's paying F-all interest, you use it to buy corporate bonds or equities. Everyone doing this at the same time as the result of QE drives up all sorts of asset prices and lowers yields, especially on corporate bonds. This makes borrowing cheaper for corps and makes asset holders nominally wealthier. The idea is that this is supposed to translate into both higher spending and investment.

    But it doesn't much.

    Another point of QE is to try and weaken the currency to stimulate exports.

    Something I'm not so sure about is what effect QE had/has on commodity prices, and whether QE was responsible for higher commidity prices, inc. oil prices. What do you think?

    ChakNovember 12th, 2012 at 10:55 pm

    Where from did FED credited the Bank's Account? Created it afresh by buying the security at face value. Money can be withdrawn from the accounts to transfer to bank's clients using third party transfers from FED. The thing is Banks don't have credit worthy avenues to lend and they are getting a risk free 25BP interest on the excess reserves with FED in return for bad assets they sold to FED.

    BobNovember 12th, 2012 at 11:21 pm

    This is the best explanation of the short comings of QE3 I have seen.

    However your last statement says this will not stimulate the economy.

    But I would like you to discuss the two possible effects it will have.

    First it is pushing interest rates for houses down which allows people to refinance and it stimulates housing purchases. It also helps corporations by allowing them to sell bonds cheaply.

    Unfortunately it takes money out of the hands of savers so they cannot spend which is drag on the economy.

    Secondly if the Fed is buying bad securities one could imagine that someday inflation will pick up and thus one should buy assets to protect oneself. That and the other advantages that corporations see drives the price of stocks up. Then those with money in stocks and those who just watch the news feel much happier(wealth effect) and consumer confidence goes up and buying goes up. I think we did see some of this.

    So better rates on debt for those that don't really need it which helps housing and the stock market which raises consumer confidence which raises spending. How significant this effect is , is the question I would like to see discussed

    peteNovember 12th, 2012 at 11:25 pm

    Thanks for stopping the troll from bothering Mr. Wray. I don't want this put out but I am glad you are screening his comments, the troll was really annoying

    jerryNovember 13th, 2012 at 1:51 am

    I'm a bit cloudy as to how reserves work as an asset class. How do the banks get rid of these reserves, only by lending? I guess the banks can't just go out and buy more treasuries with the reserves because no one takes reserves as payment?

    jonf34November 13th, 2012 at 2:30 am

    Great post and very informative. So what will be the fall out , political or otherwise, when the trash at the fed is written off. Can they keep it hidden? Who will do the foreclosures for non payment? Does the fed now own these properties?

    jonf34November 13th, 2012 at 2:39 am

    Another dumb question. If I read the chart right the fed has 2.8 trillion or so of assets and the banks have that as reserves at the fed. How do those reserves ever get cleared? and how long will it take?

    EugenRNovember 13th, 2012 at 8:53 am

    The government deficit, except of the taxation, is the only source the government can use to allocate resources. While most of the taxes are used to cover current government expenses, the deficit, if used for investment with positive future economic outcome, is as good tool to resource allocation as any other. The crucial question remains how to cover the deficit, by issuing treasury securities with payable interest, (as it is done now) or by printing directly money, that is also kind of debt, just without the need to pay interest on it. The two ways create difference in the government budget flexibility, in the future. If the government in the future will be burdened by need to pay interest on its securities,if needed fiscal stimulus at times of deflation, it will have reduced capacity to increase its expenses. This is what happens right now, due to the opposition from the legislative representation. If the government stimulus will effect finally the economy and it would turn from deflated to inflated, the best way for the government to make monetary squeeze will be reducing the credit given by the banks. And the banks don't like it. Who knows, if not the bankers lobby-ism is behind this opposition to the federal stimulus.

    James DollingerNovember 13th, 2012 at 1:21 pm

    I think bernanke is deliberately trying to manipulate the natural rate of interest to address what he correctly perceives as a shortage in private sector aggregate demand. I'm pretty sure h's building on the work of Krugman that states that liquidity traps are a result of individual's expectations of lower prices in the future. The problem with rational expectations is that it mis-states the individuals optimization function when you have debts. While in general it is true that people try to optimize their expected utility of consumption over time, if they have a debt repayement constraint the ability to service this debt will take priority given the large negative utility of declaring bankruptcy (e.g. not having a home any more, social stigma etc). The reason that households aren't spending is not that they think they can buy the next car or toaster oven cheaper three months in the future but rather they need to save money to pay off the mortgage on their house which is now 10/20% under water.

    In this framework Bernanke's QE operations are actually more pernicious that discussed above. Manipulation of the interest rate has two effects. First it promotes sub optimal allocation of capital and resources as well as acting as a tax on savers. Second, and perhaps more importantly individuals unfounded hyper inflation fears have caused massive capital flow into hard assets particularly commodities which has pushed up the price of key commodities. This has resulted in very sluggish if not negative real wage growth which further burdens a consumer trying to increase his or her savings rate.

    The biggest macro economic problem facing the global economy is that there is too much private sector debt for the current level of global economic activity. The only way to solve this problem is to either restructure obligations (which is unlikely to happen as the elites don't want to lose their foolishly lent wealth) or to increase the income/financial assets of the private sector. The only way that the entire world can increase its private sector assets at the same time, as is correctly pointed out above, is for massive deficit spending from the public sector.

    With artifiicially low interest rates there is a possibility of fairly severe inflation but inflation fears can be dealt with easily by reducing QE/raising interest rates as well as putting in actually kenysian policy i.e. rules based reductions in assistance / tax increases as economic activity recovers to full potential.

    barfNovember 13th, 2012 at 2:04 pm

    As both a Ron Paul supporter (financially speaking…you're not arguing with price again are you?) AND a supporter of the policies of 2008 i think you need to start presenting some cold hard data to start being taken seriously in your suppositions. First off you claim "this benefits Wall Street not Main Street." This is in fact of a TOTAL falsehood and the more you repeat the more you look like some clown with an ax to grind and not someone who should be taken seriously by anyone in position to say "where to from here." (Unlike me who has been spot on in so many ways it really goes to show how the key to getting published is to utter one lie after another that appears "acceptable.") First: take a look a land prices: they've have kept soaring after the collapse. Second take a look a resource prices: they have completely recovered since their collapse and in some cases SURGED higher. Take a look at final demand: "shit." Take a look at real estate prices broadly "total shit except for California and Florida." Your thesis has never held water…and it never will. QE is just a fancy pants way of creating inflation…and we'll need entire new Cities and States in order to work around its effects. The big winners as they always are are "the New New Things." that would be natural gas, the solar space and cloud computing. These INDUSTRIES have been the big winners…and those that have invested in them (Exxon Mobil, the semi-space, Oracle communications) have been rewarded…though clearly their shareholders are…as they always do…holding out for more. (of course how can they complain when the over all market has doubled off the lows?) The LOSERS are big Cities…and pretty much "big, complex anything." QE is a meat axe…not a scalpel…and thus the bulk if not totality of Urban USA is a loser. We'll see if the "crankiness" from Sandy spreads to other US Cities. I'll be looking for Apartment Reits to be built on top of Wal Mart stores as part of the "New Normal."

    HepionNovember 13th, 2012 at 3:25 pm

    Let me speak on behalf of us 333 million people who live in euro area: we need a plan to dissolve this thing. Policymakers are stuck in a old dogma and every time austerity fails they demand more austerity as a solution. What would be the least painful path towards fiscal sovereignty of member nations?

    Such a plan with all I's dotted and y's crossed could command considerable influence among european MMT followers. Founder of an economic theory always has considerable prestige in his area of expertice.

    interested readerNovember 13th, 2012 at 3:49 pm

    Japan ran an average fiscal deficit of over 5% over the past 20 years with peak deficits of around 10% or so — how big should the deficit/stimulus be since that's obviously not enough? If this fiscal stimulus only served to avoid an even worse outcome, then that's not much better than what monetary policy can achieve?

    L_Randall_WrayNovember 13th, 2012 at 7:16 pm

    Since there were a couple of comments on the same theme, let me explain: "How do the banks get rid of the excess reserves?"
    1. You run to your ATM and take out cash. While cash holding has gone up a bit in the aftermath of the crisis (you can see it in the chart), that's not nearly enuf to reduce excess reserves significantly.
    2. Banks pay back loans of reserves from Fed. They haven't borrowed much, so that too will not reduce XR much.
    3. Fed sells its treasure trove of assets (MBSs and Treasuries) back to banks. This will be the main avenue; it will be done smoothly. The only question is over how much of the MBS trash is too trashy to sell back.
    4. FedGovt runs budget surpluses, like Clinton did (the "excess taxes" are paid for taxpayers by banks that use their reserves).

    Ed Dolan EdDolanNovember 13th, 2012 at 7:35 pm

    A clear statement of some of the limits of QE during a recession. Am I correct, though, in thinking that MMT does not oppose the essence of QE, that is, the effort to keep the central bank's policy rate at or close to zero as a matter of course, and the effort to assure that as large as possible a share of outstanding government liabilities take the form of reserves rather than interest-bearing Treasury securities? If so, that means that the MMT critique of QE amounts just to saying it is useless during a slump, but during normal times, it would be an appropriate policy. Is that right?

    L_Randall_WrayNovember 13th, 2012 at 8:17 pm

    Ed: Yes I think most of us support Keynes's call to euthanize the rentier class thru ZIRP. This is permanent policy, not anti-cyclical. So, yes we have no problem with Zirp now, we just want it all the time. So the critique here is with the belief the Fed is doing something to stimulate the economy. No. They are helping to euthanize rentiers (a good thing!) but if anything they could be taking demand out of the economy.

    L_Randall_WrayNovember 13th, 2012 at 8:20 pm

    Sorry, Ed, reading my comment I can see the last sentence could be read the wrong way. Zirp might actually "take demand out of the economy" by lowering government interest payments, thus, reducing nongovt income. I realize low rates are helping homeowners who refinanced, but I've done modeling with my colleague Linwood Tauheed to show that the net impact can very well be negative.

    olly100November 13th, 2012 at 9:42 pm

    Don't forget that many of those "rentiers" are actually pensioners. "Euthanising the rentier" can only work and not be completely unpopular if the govt provides pensioners with an compensating income. So at present ZIRP is a bad thing because it is hitting pensioners badly.

    Satyajit Das takes a very different view of QE to you. Might deserve a response?

    jonf34November 13th, 2012 at 11:22 pm

    Pension funds would like to have a stable risk free source of income. Operation twist took a lot out of long term bonds, I thought. That doesn't sound good to me.

    L_Randall_WrayNovember 14th, 2012 at 12:36 pm

    Yes I know that pension funds and our elderly persons rely on interest income and prefer low risk Treasuries. We have to decide whether that is good social policy. I think not. Much better to ramp up SocSec retirement and phase out Money Manager Capitalism that relies on money managers beating the average by speculating in our food supply, etc. As Keynes argued, the return on risk-free assets ought to be Zip. So, ZIRP. Big topic; see my co-authored paper (with Yeva Nersisyan), "The trouble with pensions" at

    peteNovember 14th, 2012 at 3:17 pm

    I am not an economist, but are you sure that keynes argued the return on risk-free assets ought to be Zip. I think what you mean is that the return beyond some average return on risk free assets ought to be zero. Suppose Pete loans Randalll a tractor and Randall is very responsible with my tractor. That is a risk free loan (except for depreciation). But I still want a bushel of wheat for using my tractor( because I can't use it on my own field). But if I think I might not get my tractor back then I want two bushels of wheat to compensate for the risk of breaking my tractor. Risk free assets get a lower return than risky assets.

    L. Randall Wray L. Randall WrayNovember 14th, 2012 at 3:51 pm

    Pete: Yes, I’m sure; and he was the one who used the term (possibly invented it, I don’t know): euthanize the rentier, defined as reducing risk free rates to zero so that there would be NO RETURN (zip, nada) to holding highly liquid assets. I might be responsible but I can assure you my IOUs are NOT risk-free! Anyway, you (and all other readers) should read Chapter 24 of Keynes’s General Theory. It is fun reading, not highly technical, a masterpiece.

    robertmc1November 14th, 2012 at 7:15 pm

    This is one of the best explanations of QE I've come across and "The trouble with pensions" was interesting reading as well.

    As an aside, I've had many heated discussions with friends about why taxes don't fund government and almost always their response is: "Then why do Democrats keep insisting on raising the rates on billionaires?".

    My response is two-fold:
    1) Reducing the taxes on the poor and middle class, who are more likely to spend the increase in income, produces more aggregate demand than reducing taxes on the rich.
    2) Concentrated wealth destroys democracies. This is a hard one to prove but I would say the ever-rising income inequality our country suffers from is skewing government laws, regulations and favoritism to the point where our "democracy" is in question.

    L. Randall Wray L_Randall_WrayNovember 14th, 2012 at 8:42 pm

    Charley: not sure why your comment did not go through as it looks like it was approved. In any case, Yes Fed could forgive the mortgage debt on the trashy MBS’s it owned. The process could be difficult, and it will force Fed to take complete loss on these–reducing its profitability. That is not an economic concern but could be a political concern.

    EconoMonitorsNovember 14th, 2012 at 10:14 pm

    Charley: not sure why your comment did not go through as it looks like it was approved. In any case, Yes Fed could forgive the mortgage debt on the trashy MBS's it owned. The process could be difficult, and it will force Fed to take complete loss on these–reducing its profitability. That is not an economic concern but could be a political concern. (L. Randall Wray)

    EconoMonitorsNovember 14th, 2012 at 10:15 pm

    Pete: Yes, I'm sure; and he was the one who used the term (possibly invented it, I don't know): euthanize the rentier, defined as reducing risk free rates to zero so that there would be NO RETURN (zip, nada) to holding highly liquid assets. I might be responsible but I can assure you my IOUs are NOT risk-free! Anyway, you (and all other readers) should read Chapter 24 of Keynes's General Theory. It is fun reading, not highly technical, a masterpiece. (L. Randall Wray)

    KenNovember 15th, 2012 at 3:37 am

    I'm not sure I agree with the comments about the Fed buying up trashy MBS. I believe the Fed is only lawfully allowed to purchase agency (i.e. Fannie Mae, etc) backed securities. You could argue that those agencies are still guaranteeing crappy mortgages (I wouldn't know), but the decision to publicly back them has already been made by the elected part of the government before the Fed can even touch them. So from the Fed point of view they are safe bets.

    KenNovember 15th, 2012 at 3:55 am

    Another point … I don't think that most holders of MBS or Gov't securities are banks. So when the Fed makes a purchase from a non-bank holder, not only do reserves go up, but the seller also gets credited with a cash balance.

    It seems like a lot of the MMT discussion assumes that these securities are simply traded back and forth between the Fed and banks, but I don't think that's the case. Last time I looked at a Treasury report, banks were far from the biggest holders of Gov't securities.

    I'm not sure that this matters much to the analysis. I think Warren Mosler would simply say that these are savers and not spenders, and will simply accept the cash balance at their indifference level in exchange for the bonds.

    L_Randall_WrayNovember 15th, 2012 at 1:02 pm

    ken: we are studying exactly what they bought and will be reporting it. I believe the Fed has bought a lot of private label securities altho as you say MOST of the purchases are trashy but insured. There are rumors the Fed is moving trashy stuff to Fannie/Freddie. So again the problem is not economic (Treasury is on the hook for all the insured ones no matter where they are) but rather political. Think about the Congressional outcry that is just down the road a bit when they find out there's tons of trash at the Fed and the GSEs.

    jerryNovember 20th, 2012 at 2:25 am

    QE1 was the MBS one, right? So you're saying the Fed just bought this garbage from some hedge fund or private money manager? Man that would be shameful on a whole new level..

    19451949November 20th, 2012 at 12:42 pm

    Are the QEs simply a means of removing bad securities from bank's balance sheets ?

    This appears to be the case..First, there was FedZero and now we have FedMBS…
    Under the guise of saving the economy, it is merely a repair-a-bank scheme? If is this is correct, there is nothing more to say about the Central Bank…


    Ray PhenicieNovember 22nd, 2012 at 8:30 pm

    I agree with the premise behind trashing reliance on interest income (as MMT is fond of pointing out, paying interest on government bonds is just additional manipulation that is not needed to keep our money system going) and also with ditching Money Manger Capitalism-like we really need an arcane art form that centers around placing bets on whether or not people will purchase bread at some future date!

    However, what about old fashioned stock companies that sell shares to interested investors- the payoff being the investment in a risky endeavor that realizes a successful development of a unique opportunity-like an undeveloped technology? In theory, there is nothing wrong with this original idea that I can see-except that the actual marked never really was freed from government favoritism.

    flow5November 24th, 2012 at 5:30 pm

    "In the case of Fed purchases of Treasuries, this reduces bank interest income—making them less profitable"

    (1) How do POMOs reduce bank income when CB lending isn't reserve constrained?

    (2) What the payment of interest on excess reserve balances does is induce dis-intermediation (where the size of the non-banks shrink, but the size of the commercial banking system remains unaffected).

    19451949November 26th, 2012 at 2:14 am

    "3. Fed sells its treasure trove of assets (MBSs and Treasuries) back to banks. This will be the main avenue; it will be done smoothly. The only question is over how much of the MBS trash is too trashy to sell back."

    Professor Wray, then that answers my question which was never replied to…So the Central Bank's QEs are essentially repair-a-bank-balance-sheet scheme..

    And will the trashy MBS be written off as losses by Bank Bernank? Will the lost impair the Fed? Is the Fed an extension of the FDIC ?

    khnApril 11th, 2013 at 9:05 am

    If budget deficit is not such a bad thing, then why dont developing economies simply used it as a tool to boost their economies withoug worrring much about inflation?

    L. Randall Wray L. Randall WrayApril 11th, 2013 at 12:20 pm

    Exactly. Use their own sovereign currency to maintain full emp through a job guarantee, with workers helping to develop their economies. A no brainer. But nobody has the brains to do it.