More on quantitative easing (and credit easing) Understanding the difference between quantitative easing in Japan and the United States
More on quantitative easing (and credit easing)
- To get a better understanding of quantitative easing
- in the American context, especially the context
- that Ben Bernanke is talking about,
- I want to read this quote from a speech that
- Ben Bernanke gave at the London School of Economics
- on January 13th, 2009. So this is shortly
- after a lot of the craziness of the financial crisis
- was happening but it was still going on.
- And he's saying, "Our approach, which could be described as
- 'credit easing' -- resembles quantitative easing in one respect."
- He's saying it's not quite quantitative easing,
- although it really is.
- "It involves an expansion of the central bank's balance sheet."
- So just to understand what he's talking about,
- the central bank, it has liabilities and assets,
- like any corporation, and they have to,
- the liabilities, plus the equity has to match up to the assets.
- Just for simplicity, let's just have the assets and the liabilies
- lining up together. So let's say that this is the central bank's
- balance sheet right over here.
- This is their current assets, and let's say
- that is is their liabilities over here,
- so liabilities, and then this is their equity,
- although the federal reserve's equity is a little bit strange,
- it's not like traditional equity, that they get all the
- excess profits and all of that, all the excess
- profits actually go to the US government.
- But when the fed prints money, what they literally do
- is that they create offsetting liabilities and assets
- So when they print money they'll, so literally
- let's say that they're printing some money right over here,
- so that's money that they're printing,
- so this is literally, it would be federal reserve notes
- being created, so these are notes, which are essentially dollar bills.
- So these are dollar bills right here being printed,
- either physically or electronically.
- And then they have an offsetting liability
- which is just notes outstanding, which is literally saying
- that hey, these are notes that we've created.
- Notes outstanding is the other side of the balance sheet.
- So, just to parse the statement, when he says, "credit easing
- resembles quantitative easing in one respect
- it involves an expansion of the central bank's balance sheet."
- So this is the expansion of the central bank's balance sheet.
- Which is essentially the same thing as printing money.
- And the federal bank will get these notes into
- circulation by going out into the market
- and buying assets.
- Traditionally, when the fed is more focused on
- short-term interest rates,
- on overnight borrowing rates between banks,
- it will use these to buy shorter-term debt
- that increases the amount of currency out there
- the amount of dollars out there, and so it will
- lower the interest rate for people buying
- and selling dollars, or I should say
- borrowing and lending dollars, not buying and selling.
- Borrowing and lending dollars, the overnight rate
- for banks will go down because there's more dollars out there,
- the cost of borrowing them will go down.
- That's normally what the fed is concerned about.
- And they're saying, look, quantitative easing is just
- this idea of expanding that balance sheet.
- Let's keep reading:
- "However, in a pure quantitative easing regime,
- the focus of quality is the quantity of bank reserves,
- which are liabilities of the central bank;
- the composition of loans and securities on the asset side
- of the central bank's balance sheet is incidential."
- So he's saying in traditional quantitative easing,
- the central bank says look, I just care about printing money
- I just care about printing money,
- So their liabilities increase accordingly.
- So this is notes outstanding again,
- And the height here is proportional to how much money
- they print, so maybe this is another trillion
- dollars they're printing.
- But what the federal reserve is saying, in traditional
- quantitative easing, all the central bank cares about
- is printing this money and getting it out there
- into circulation, and they don't really care
- what they're using this money for.
- So whenever they get this money into circulation
- they do go out there and they do buy assets
- usually treasury assets,
- and then they say even, "Indeed, although the
- bank of Japan's policy," -- so he's comparing
- relative to what Japan did when they kind of faced deflationary crisis.
- "Indeed, although the bank of Japan's policy approach
- during the quantitative easing period was quite
- multifaceted, the overall stance of its policy
- was gauged primarily in terms of its target for bank reserves."
- So you're saying look, the Japanese were trying to fight
- a deflationary bank crisis, they kept printing money
- so they kept increasing the liability side of their
- balance sheet, they kept printing money
- and they did use this money for a bunch of stuff,
- they did use that money to go buy a bunch
- of assets, but their focus of their intervention
- was just, how much did they print?
- They didn't really care, they didn't really
- engineer where that money went to.
- They really weren't trying to change what happens
- in the markets that they were participating in.
- Let's keep reading what the fed is saying.
- "In contrast, the Federal Reserve's credit easing
- approach focuses on the mix of loans and securities
- that it holds and on how this composition of assets
- affects credit conditions for households and businesses."
- So what he's saying is that, we are mechanically
- doing the same thing that Japan did,
- we're increasing our balance sheet, which is analogous to printing money
- And we are also buying a bunch of stuff,
- just like Japan did,
- Japan had a multifaceted approach,
- that's how they put the money into circulation,
- but what Bernanke is saying
- is that our approach isn't just focused on the amount
- of cash that we are printing, our focus is
- where are we putting that cash toward,
- how can we use this cash that we printed
- to kind of, provide liquidity, to ease up things
- in certain parts of the economy. To understand
- what he's talking about, let me draw
- a yield curve right over here.
- Let me draw this yield curve right over here,
- so this is maturity on the horizontal axis,
- and this is yield,
- and I'm gonna draw the yield curve for treasuries.
- So let's say the short-term overnight borrowing for,
- let's say, let's do the yield curve for treasuries,
- maybe it looks something like this.
- So short-term interest rates are already
- pretty darn close to zero, and maybe you know
- this is some, I don't know what percentage,
- maybe this is like 4% or something.
- It's not accurate, but just gives you an idea.
- So this is the treasury yield curve.
- Now you could also have a yield curve for other types of
- debt. Maybe you have AAA corporate debt,
- a very safe corporate debt, a perceived safe corporate debt,
- but it's not quite as safe as US treasuries,
- so maybe it's yield curve might look something like this
- and this difference, for any maturities,
- maybe this is a 10 year,
- this is 10 year debt right here.
- This difference between this AAA corporate debt
- and the treasury, that is the yield spread.
- And maybe the fed is able to, through intervention,
- first they're able to print money,
- normally they buy shorter-term debt,
- maybe they start buying longer-term treasury debt,
- and maybe that helps get the yield curve,
- for longer-term treasuries down a little bit.
- Helps bring it down.
- But maybe the AAA corporate debts
- don't react, maybe the spread doesn't stay constant
- maybe the spread widens. Maybe the same thing
- for other types of debt. This is highly rated
- mortgage backed securities, maybe they have a
- slightly higher interest rate.
- And once again, even though the treasury interest rates
- are coming down, while they're intervening
- because of all the craziness that is happening in the economy,
- the spread between treasuries, and AAA mortgage
- backed securities, or the spread between treasuries
- and AAA corporate debt
- that widens, or another way to think about it
- is the treasury interest rates are coming down
- while these things aren't following it,
- so what Ben Bernanke is saying, look we are doing
- quantitative easing, we are printing money
- and we are using that money to go buy things in the economy
- and we're increasing the amount
- of cash that there is in the economy,
- but our point isn't to increase the amount
- of reserves, or increase the amount of cash,
- because it's really not changing the behavior
- of banks. What we are going to do is
- go buy things like highly rated mortgage backed securities,
- or things like commercial paper, AAA corporate debt,
- so that those things, the interest on those things
- goes down. Obviously if someone is willing to pay more
- for a certain amount of debt,
- and I've gone over this in another video,
- maybe it's not so obvious,
- then the interest rates on it will go down.
- And so what they're doing is, what Bernanke is saying,
- is he cares more about what winds up on the
- asset side of the Fed's balance sheet,
- because it takes these dollars that it printed,
- and goes and buys other stuff,
- and it wants to put some mortgage backed securities
- over here, it wants to put some AAA corporate debt
- over here. And maybe it also does some longer term
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