In my interminable Zero Hedge-themed rant I made passing reference to “quantitative easing“. It occurs to me that I didn’t devote nearly enough time to the vitally important question of what quantitative easing is. To rectify that: quantitative easing is a euphemism for printing money.
Neologism
The term “quantitative easing” (QE) seems to have been cooked up in 1994. It appears to have originally referred to the purchase of “non-traditional financial assets”, such as commercial paper, by central banks. Its current meaning seems a bit slippery: the much discussed “QE2” appears to consist only of purchases of Treasuries (i.e., “traditional” financial assets) by the Fed.
Printing Money
QE really is about printing money, just in sort of a roundabout way. Here’s a story to illustrate this point.
- Let’s say the U.S. Gov’t wants to buy something useful and beautiful: a Lockheed Martin F-22 Raptor.
- Lockheed Martin insists on being paid for their planes, and I want to keep this example simple, so the U.S. Gov’t hands them a gigantic duffle bag containing USD$150,000,000.
- The U.S. Gov’t doesn’t have this money on hand as it’s already spent the USD$2.7T that it’s collected in taxes, so it has to fill the duffle bag with borrowed cash.
- The U.S. Gov’t borrows money by selling securities to the public. It prints up some Treasuries, sells them for cash, puts the cash in the bag, gives the bag to Lockheed Martin, and flies away its fighter.
- Later, the Fed buys the Treasuries back from the public. In exchange for the securities, the Fed gives them dollars. Where does the Fed get those dollars? It just prints them.
Granted, it’s a different part of the gov’t doing the printing from the one that’s doing the buying, and the printing part of the gov’t supposedly isn’t printing money just so the buying part can magic itself up a shiny new fighter. Nevertheless, money is being printed, and that newly printed money is financing (some part of) gov’t operation.
Distinctions with Differences
The most confusing thing about QE is how one ought to disambiguate it from the normal “open market operations” (OMO) that central banks conduct under an interest rate targeting regime. Such operations include the purchase of securities by the Fed, i.e., exactly what is now described as QE.
The distinction between OMO and QE seems to be one of rationale; if securities are purchased in the service of an interest rate target, it’s an example of OMO. If the purchases are made simply to inflate the money supply, it’s an instance of QE.
The significance of this distinction seems to be that OMO are limited by the targeted interest rate, while QE is employed when the interest rate has been driven near zero. Therefore, there’s no external metric limiting the central bank’s purchases. They can buy as much as they want, with all the money they can print.
That seems slightly worrying.
