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Fed is Doing Its Best to Help Wall Street

Current word on the street is that the Federal Reserve Bank is close to implementing “Quantitative Easing 2.0”.  It’s 2.0 because Fed did the same thing at the beginning of the financial crisis in order to prop up Wall Street.  The idea behind Quantitative Easing (QE) is based on a flawed economic theory that the Fed can stimulate the economy through monetary policy.  QE will only serve to help Wall Street and its trading profits, again. 

Monetary policy is the actions taken by the Federal Reserve Bank to influence money supply and short-term interest rates supposedly to support employment (or often case unemployment) and price stability (inflation) in the economy.  Fed basically tries to influence the amount of liquidity in the financial system.  It uses mainly three tools to implement monetary policy: 1) open market operations; 2) discount rate and 3) fed funds rate.  However, during the financial crisis the Fed did implement some unconventional tools such Special Purpose Vehicles (Maiden Lane I, II, III are examples) to increase liquidity in financial system and prop up Wall Street. 

If the Fed decides to implement QE 2.0 then it will use open market operations to do so.  Open market operations involves the purchase or sale of U.S. Treasury Securities or other federal agency bonds.  The objective with purchase or sale is to influence a desired quantity of banking reserves held at the Fed or a desired federal funds rate.  The federal funds rate is the interest rate at which depository institutions lend balances at the Federal Reserve to other depository institutions overnight.

As for QE 2.0, Prof. Bill Mitchell describes it this way:

Quantitative easing merely involves the central bank [the Fed] buying bonds (or other bank assets) in exchange for deposits made by the central bank in the commercial banking system – that is, crediting their reserve accounts. The aim is to create excess reserves which will then be loaned to chase a positive rate of return. So the central bank exchanges non- or low interest-bearing assets (which we might simply think of as reserve balances in the commercial banks) for higher yielding and longer term assets (securities).

So quantitative easing is really just an accounting adjustment in the various accounts to reflect the asset exchange. The commercial banks get a new deposit (central bank funds) and they reduce their holdings of the asset they sell.

The idea of QE is based on the incredibly flawed money multiplier theory and that if the Fed supplies liquidity to banking system that will encourage them to make loans because banks need reserves to lend.  First, this is a complete misunderstanding of how banking system generates loans - it doesn’t need reserves to make loans.  Second, even with all the liquidity from QE 1.0 and increase reserves banks are still NOT lending.  Commercial banks are sitting on the excess reserves plus using some liquidity to trade in other markets.

This a graph of amount of excess reserves:

And here is graph (via Ezra Klein) of Wall Street profits as a percentage of all domestic profits:

Nice.  But what about those so important business loans:

QE 2.0 is not going to change this. However, it may give Wall Street more opportunities to profit from trading or may even create asset bubbles some place else.  It is clear - QE 2.0 won’t stimulate the economy. 

Good luck.