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It's a common misconception, but QE does not change the ability of private banks to make loans in any way. If you think I am wrong about this, please explain th

It's a common misconception, but QE does not change the ability of private banks to make loans in any way. If you think I am wrong about this, please explain the mechanism by which you think QE increases the ability of private banks to make loans. In fact, there are almost no serious arguments for why QE should stimulate the economy in any way, except for a small straw, which is that QE might reduce long-term interest rates, and that this drop of long-term interest might induce more people to take out bank loans and increase their spending in this way. Also, yes, Quantitative Easing might lead to inflation, but this is exactly what people hope for in the first place :-) And no, Quantitative Easing will not lead to uncontrollable inflation. If loan-driven inflation gets too high, the central bank can simply decide to raise interest rates and stop QE again.

foobarqux 13y ago
> If you think I am wrong about this, please explain the mechanism by which you think QE increases the ability of private banks to make loans. Not the parent but I thought depository and possibly other types of loans were limited by the size of reserves.
- nhaehnle 13y ago
  The rules say that amount of reserves held by a bank must be at least r * X, where r is the reserve ratio and X is the amount of deposits owed by the bank. That is, there is absolutely no link between loans and reserves in the rules (laws and regulations). As long as the amount of reserves is close to the legally required minimum amount, there is an indirect link between loans and reserves, but its causality goes in the other direction as traditionally believed. When the volume of loans increase, then deposits increase also. Then the banking system as a whole needs more reserves. If the amount of reserves available were fixed, this would lead to banks bidding up the overnight interbank interest rate. However, after some disastrous experiments in the 1970s and 80s with alternative policies, central bank policy is to keep that interest rate fixed. And that means: the central bank accommodates the banks' desire for more reserves by buying assets from the banking system. Conversely, banks bid down the overnight interbank interest rate towards zero if there are too many reserves in the system, unless the central bank pays interest on reserves. This is exactly what central banks in most of the Western world want to happen today. In any case, the story is that the amount of loans made by banks causally sets a lower bound on the amount of reserves in the system. The reverse direction does not hold. Again, anybody who believes the latter would have to exhibit an explicit mechanism that establishes a reverse causality. There is no such mechanism in the rules (i.e. laws or regulations). Oh, and if you are appalled because you believe that all this means that banks can just make loans as they please: they can't. However, the limits on loans are set by capital requirements, and for good reason: capital is a suitable buffer against defaulting loans, reserves aren't.
  - foobarqux 13y ago
    So say I have $100 of deposits, reserve ratio 0.1, lend out $90. My reserves are $10. Now say the government increases my reserves by $5. Can't I now lend out an additional $5 that I wasn't able to before?
    - nhaehnle 13y ago
      Again, that's not how it works. You don't need the reserves at all (if you're a bank; if you're not a bank, then you have never in your life held reserves, and the way you may or may not be able to make loans is qualitatively different). When a bank makes a loan, they simply create a new deposit, say worth 100#. If the reserve ratio is 0.1, and assuming that bank had exactly the required reserves before this operation, then they will have to acquire 10# in additional reserves within a week or two (yes, you read that correctly; reserve requirements are after-the-fact requirement that can be fulfilled with some delay). More likely, though, the person or company that the loan was made to will use these 100# to pay somebody else, and in doing so, the newly created deposit is transfered to another bank B. To balance this transfer, bank A must transfer 100# in reserves to bank B. Usually, it will simply borrow those reserves from bank B against an appropriate collateral such as the loan it has made. The profit of bank A from the loan is the different in interest between the interest owed by their customer, and the interest they have to pay in the interbank market to bank B. At the same time, bank B now has an increased reserve requirement, and they need to get those 10# from somewhere. As I explained previously, this will lead to the interbank rate being bid up if there are no excess reserves in the system. When that happens, the central bank buys assets from banks in exchange for new reserves (instead of outright buying, a repurchase agreement may be made). However, banks also have the option to directly borrow reserves from the central bank, at a fixed interest rate.
      - foobarqux 13y ago
        Thanks for taking the time to reply, it was informative. To summarize: banks aren't constrained by reserve ratios because they can borrow reserves from other banks or, if total reserves are low, from the central bank whose policy is not to let total reserves get low due to the impact on interbank rates. Is that correct? Do you work in finance? Can you recommend any books on money?

foobarqux 13y ago

> If you think I am wrong about this, please explain the mechanism by which you think QE increases the ability of private banks to make loans. Not the parent but I thought depository and possibly other types of loans were limited by the size of reserves.

nhaehnle 13y ago
The rules say that amount of reserves held by a bank must be at least r * X, where r is the reserve ratio and X is the amount of deposits owed by the bank. That is, there is absolutely no link between loans and reserves in the rules (laws and regulations). As long as the amount of reserves is close to the legally required minimum amount, there is an indirect link between loans and reserves, but its causality goes in the other direction as traditionally believed. When the volume of loans increase, then deposits increase also. Then the banking system as a whole needs more reserves. If the amount of reserves available were fixed, this would lead to banks bidding up the overnight interbank interest rate. However, after some disastrous experiments in the 1970s and 80s with alternative policies, central bank policy is to keep that interest rate fixed. And that means: the central bank accommodates the banks' desire for more reserves by buying assets from the banking system. Conversely, banks bid down the overnight interbank interest rate towards zero if there are too many reserves in the system, unless the central bank pays interest on reserves. This is exactly what central banks in most of the Western world want to happen today. In any case, the story is that the amount of loans made by banks causally sets a lower bound on the amount of reserves in the system. The reverse direction does not hold. Again, anybody who believes the latter would have to exhibit an explicit mechanism that establishes a reverse causality. There is no such mechanism in the rules (i.e. laws or regulations). Oh, and if you are appalled because you believe that all this means that banks can just make loans as they please: they can't. However, the limits on loans are set by capital requirements, and for good reason: capital is a suitable buffer against defaulting loans, reserves aren't.
- foobarqux 13y ago
  So say I have $100 of deposits, reserve ratio 0.1, lend out $90. My reserves are $10. Now say the government increases my reserves by $5. Can't I now lend out an additional $5 that I wasn't able to before?
  - nhaehnle 13y ago
    Again, that's not how it works. You don't need the reserves at all (if you're a bank; if you're not a bank, then you have never in your life held reserves, and the way you may or may not be able to make loans is qualitatively different). When a bank makes a loan, they simply create a new deposit, say worth 100#. If the reserve ratio is 0.1, and assuming that bank had exactly the required reserves before this operation, then they will have to acquire 10# in additional reserves within a week or two (yes, you read that correctly; reserve requirements are after-the-fact requirement that can be fulfilled with some delay). More likely, though, the person or company that the loan was made to will use these 100# to pay somebody else, and in doing so, the newly created deposit is transfered to another bank B. To balance this transfer, bank A must transfer 100# in reserves to bank B. Usually, it will simply borrow those reserves from bank B against an appropriate collateral such as the loan it has made. The profit of bank A from the loan is the different in interest between the interest owed by their customer, and the interest they have to pay in the interbank market to bank B. At the same time, bank B now has an increased reserve requirement, and they need to get those 10# from somewhere. As I explained previously, this will lead to the interbank rate being bid up if there are no excess reserves in the system. When that happens, the central bank buys assets from banks in exchange for new reserves (instead of outright buying, a repurchase agreement may be made). However, banks also have the option to directly borrow reserves from the central bank, at a fixed interest rate.
    - foobarqux 13y ago
      Thanks for taking the time to reply, it was informative. To summarize: banks aren't constrained by reserve ratios because they can borrow reserves from other banks or, if total reserves are low, from the central bank whose policy is not to let total reserves get low due to the impact on interbank rates. Is that correct? Do you work in finance? Can you recommend any books on money?