I've been watching some lectures by Ben Bernanke at GW Univ. and investigating their Large Scale Asset Purchase (i.e. Quantitative Easing) programs, but I still don't understand where the roughly $2 trillion came from to make those purchases. He and the Fed website explains it as coming from electronically "adding to the reserves held by banks at the Fed." That still doesn't tell me where the $2 trillion came from. In fact, it almost sounds like it was merely added electronically to the balance sheet as if created out of thin air. I don't really believe that was the case but I'm having a hard time finding any more detailed description. Any help would be appreciated.
I think I partially found the answer I was looking for, but still seek some insight from any banking - Fed gurus. In the QE ("LSAP") programs, the Fed did sort of create its asset purchasing ability out of thin air. It wasn't by "printing money", as critics usually charge. Rather, it seems like it was more of a temporary electronic expansion of its bank reserves for the purpose of massively purchasing mainly Treasuries. The supply of currency wasn't affected but the monetary basis was, since that includes banking reserves. The effect is to lower long term interest rates as a last ditch effort to spur economic growth when the normal methods that focus on lowering short term interest rates fails. I'm still foggy as to how the mechanics. I'm surprised that I'm having such difficulty finding a detailed description of the mechanics of expanding the banking reserves - even in Google Scholar. Even top notch undergrad Economics textbooks, some by Harvard and MIT professors, gloss over the Fed and how it works.
Just so you understand, almost all the money in the world exists only on electronic balance sheets. The Fed's job is to control the amount of money in the US economy. In order to accomplish this it needs the ability to both create and destroy money, which it can do entirely electronically through a number of methods that change the amount of reserves held at its members, the regional reserve banks. For the most part the regional reserve banks hold the reserves of their own members, which are private banks. The method Bernanke was referring to was not among the usual methods used in the past. It was to simply decide that the regional reserve banks had more money than just the reserves of member private banks and add that amount to their balance sheets, which they then used to purchase private debt on the open market, which increased the amount of money in the economy. It was called quantitative easing because its purpose was to decrease private debt holdings and increase the amount of money in the private sector available for lending. So, the Fed did conjure that $2Trillion out of thin air but it can just as easily make that money disappear overnight by selling the $2Trillion in debt it bought with it. When the Fed buys it adds money to the economy and when it sells it removes it. The Fed has an almost unlimited ability to both add money and remove it from the economy whenever it wants at a scale that no other entity in the entire world economy is capable of. The usual methods that the Fed deployed to adjust the money supply were to change the amount of reserves its member private banks must deposit with it, buy or sell government bonds, and adjust the interest rate that it charged for lending to member banks, i.e. the "prime rate", which has enormous influence on interest rates across the entire economy. There is a lot more that you should learn, there is a number of Wikipedia entries about the Fed and its various activities which have voluminous references to academic texts that might be of interest.
Thanx for that clarification! I didn't how exactly the level of "banking reserves" was adjusted - i.e. whether it was an actual transfer of existing assets from regional reserves or somewhere else, or strictly an electronic adjustment of their balance sheets without reference to some existing assets. I think I read that they then used those extra reserves to make the purchases of the (mainly) Treasuries competitively, on the commercial markets. I assume the the so-called "unwind" process will be a matter of reversing that purchasing process, correct? I also found it interesting that the Fed has earned hundreds of billions in interest on those bonds and notes and those earning went to the Treasury, helping to pay for Congress's incurred debt. That almost sounds too good to be true. Am I missing something here? But it appears to work and the fears of inflation, even by members of the Fed itself, surprisingly haven't materialized. Even Ben B. was very hesitant to utilize this process, owing to dangers of creating long term inflation that they'd then have to deal with down the line. Meanwhile, long term interests were stimulatively brought lower - the main objective, correct? And that even helped drive mortgage rates to very appealing lows seen in 2011 and 2012. I don't see any negatives here. What am I missing?
Actually, quantitative easing purchases were privately issued bonds and other securities. The Feds usual action is to buy Treasuries so buying commercial debt on the open market was unprecedented. And yes, the Fed can easily sell them anytime it wants and has made quite a windfall of profit that has been transferred to the Treasury, not hundreds of $Billions, more like tens of $Billions. The Fed has also stopped paying interest on excess reserves deposited by its member banks. This has stopped banks from borrowing at low rates and depositing the money as excess reserves in order to get the interest rate on reserves that was set by Congress a few years ago. Anyway, the end result is a huge amount of money flooding into the markets, not the rest of the economy. All the inflation, and all the increased money supply and all the income from economic growth is being sequestered in the booming markets. There is little in the wider economy that can generate inflationary pressure, especially since oil prices have collapsed and are unlikely to recover anytime soon. This is putting more pressure on prices to decline than to rise. Some tiny gains in aggregate wages are starting to appear but that has a long way to go before recovering to levels before the recession. In any case, the Fed holds so much debt that is could easily remove a few $Trillion from the economy overnight if inflation became a problem. In fact, the biggest economic problem right now is that the $US is becoming too strong, gaining in value against all other currencies at a rate that will put many foreign economies in acute danger if it continues for much longer. The rising $US is also making imports cheaper for US consumers. btw, Fannie and Freddie are also transferring their profits to the Treasury. Since paying back their bailout funding and are on track to pay about $50Billion a year into the Treasury going forward.
