Why QE3 Won’t Jumpstart the Economy — and What Would

The Circulating Money Supply – Published on Global Research.ca, by Ellen Brown, September 21, 2012.

The economy could use a good dose of “aggregate demand”—new spending money in the pockets of consumers—but QE3 won’t do it. Neither will it trigger the dreaded hyperinflation. In fact, it won’t do much at all. There are better alternatives … //

… Why QE3 Won’t Expand the Circulating Money Supply:

In its third round of QE, the Fed says it will buy $40 billion in MBS every month for an indefinite period.  To do this, it will essentially create money from nothing, paying for its purchases by crediting the reserve accounts of the banks from which it buys them.  The banks will get the dollars and the Fed will get the MBS.  But the banks’ balance sheets will remain the same, and the circulating money supply will remain the same.

When the Fed engages in QE, it takes away something on the asset side of the bank’s balance sheet (government securities or mortgage-backed securities) and replaces it with electronically-generated dollars.  These dollars are held in the banks’ reserve accounts at the Fed.  They are “excess reserves,” which cannot be spent or lent into the economy by the banks.  They can only be lent to other banks that need reserves, or used to obtain other assets (new loans, bonds, etc.).  As Australian economist Steve Keen explains:

[R]eserves are there for settlement of accounts between banks, and for the government’s interface with the private banking sector, but not for lending from.  Banks themselves may . . . swap those assets for other forms of assets that are income-yielding, but they are not able to lend from them.

This was also explained by Prof. Scott Fullwiler, when he argued a year ago for another form of QE—the minting of some trillion dollar coins by the Treasury (he called it “QE3 Treasury Style”).  He explained why the increase in reserve balances in QE is not inflationary:

Banks can’t “do” anything with all the extra reserve balances.  Loans create deposits—reserve balances don’t finance lending or add any “fuel” to the economy.  Banks don’t lend reserve balances except in the federal funds market, and in that case the Fed always provides sufficient quantities to keep the federal funds rate at its . . . interest rate target. Widespread belief that reserve balances add “fuel” to bank lending is flawed, as I explained here over two years ago.

Since November 2008, when QE1 was first implemented, the monetary base (money created by the Fed and the government) has indeed gone up.  But the circulating money supply, M2, has not increased any faster than in the previous decade, and loans have actually gone down.

Quantitative easing has had beneficial effects on the stock market, but these have been temporary and are evidently psychological: people THINK the money supply will inflate, providing more money to invest, inflating stock prices, so investors jump in and buy.  The psychological effect eventually wears off, requiring a new round of QE to keep the game going.

That is what happened with QE1 and QE2.  They did not reduce unemployment, the alleged target; but they also did not drive up the overall price level.  The rate of price inflation has actually been lower after QE than before the program began.

Why, Then, Is the Fed Bothering to Engage in QE3? … //

… Some Possibilities That Might Be More Effective at Stimulating the Economy:

An injection of money into the pockets of consumers would actually be good for the economy, but QE3 won’t do it.  The Fed could give production and employment a bigger boost by using its lender-of-last-resort status in more direct ways than the current version of QE.

It could make the very-low-interest loans given to banks available to state and municipal governments, or to students, or to homeowners.  It could rip up the $1.7 trillion in government securities that it already holds, lowering the national debt by that amount (as suggested a year ago by Ron Paul).  Or it could buy up a trillion dollars’ worth of securitized student debt and rip those securities up.  These moves might require some tweaking of the Federal Reserve Act, but Congress has done it before to serve the banks.

Another possibility would be the sort of “quantitative easing” first proposed by Ben Bernanke in 2002, before he was chairman of the Fed—just drop hundred dollar bills from helicopters.  (This is roughly similar to the Social Credit solution proposed by C. H. Douglas in the 1920s.)  As Martin Hutchinson observed in Money Morning:

With a U.S. population of 310 million, $31 billion per month, dropped from helicopters, would have given every American man, woman and child an extra crisp new $100 bill per month.

Yes, it would produce an extra $31 billion per month on the nominal Federal budget deficit, but the Fed would have printed the new bills, so there would have been no additional strain on the nation’s finances.

It would be much better than a new social program, because there would have been no bureaucracy involved, just bill printing and helicopter fuel.

The money would nearly all have been spent, increasing consumption by perhaps $300 billion annually, creating perhaps 3 million jobs, and reducing unemployment by almost 2%.

None of these moves would drive the economy into hyperinflation.  According to the Fed’s figures, as of July 2010, the money supply was actually $4 trillion LESS than it was in 2008.  That means that as of that date, $4 trillion more needed to be pumped into the money supply just to get the economy back to where it was before the banking crisis hit.

As the psychological boost from QE3 wears off and the “fiscal cliff” looms, perhaps Congress and the Fed will consider some of these more direct approaches to relieving the economy’s intractable doldrums. (full text).

(Ellen Brown is an attorney and president of the Public Banking Institute.  In Web of Debt, her latest of eleven books, she shows how a private cartel has usurped the power to create money from the people themselves, and how we the people can get it back. Her websites are Web of Debt.com, Ellen Brown.com, and Public Banking Institute.org).

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