Have you ever heard the term "quantitative easing?" If you're a normal college student, probably not. If you keep up with the news, maybe once or twice. If you're an obsessed policy wonk (like me!) then almost certainly. Should you know about quantitative easing? Absolutely. It's one of the most important things happening this recession.
You probably heard a couple of weeks ago - March 19, to be precise - that the Federal Reserve announced it was going to inject another trillion dollars into the economy. Why should that concern you? Well, most importantly, the Fed is employing the "helicopter" strategy. Essentially, it is dropping money onto Wall Street. The Federal Reserve is the only entity in the United States permitted to create money; it is exercising that authority with nearly free abandon now.
They are doing it by spending about $750 billion to directly buy troubled assets from banks. In other words, money that did not exist before the transaction enters the economy as worthless securities leave the economy to spend the rest of their sorry lives on the Federal Reserve's balance sheets. The Fed is doing this in addition to its usual open-market operations, discount window interest rates and reserve requirements.
Its usual money supply control options are currently ineffective because of the contortions of the financial system. Ordinarily, banks are happy to get rid of excess reserves and have it out making money, but since banks are not sure who's solvent and who's not, reserves are far in excess of what is required. As a consequence, lowering those required reserves does nothing.
Meanwhile, the discount window rate is 0 percent: banks can get free money from the Fed. That's not working. And the Fed is unloading securities like crazy - the value of securities held by the Federal Reserve dropped more than $200 billion last year.
So to expand the money supply and, hopefully, counteract the deflationary pressure of a major recession, the Fed has to figure out how to get the money it prints into the economy. Short of mailing a pack of $100 bills to every American, the Fed has decided to print money and hand it to banks in return for those banks' mistakes. And that's what it is doing - to the tune of $750 billion. And it is buying $300 billion-worth of securities directly from the Treasury.
This strategy is worrisome for several reasons. First, everyone knows that printing money causes inflation. The money supply at the beginning of the recession was nearly $8 trillion, and all told the Fed is printing $2 trillion; if these were normal economic circumstances, we would expect an inflation rate during the course of these operations of more than 20 percent. But these are not normal circumstances: the rate at which money is being spent has plummeted since banks have stopped lending and started hoarding cash. The real problems will show up when enough toxic assets are out of the economy (and into the government) that the velocity of money picks up again. When that happens, the effective amount of money in the economy will increase, which will result in inflation if the Fed can't pull the money out of the economy quickly enough.
Second, the Fed is buying bonds directly from the Treasury. Usually the Fed buys and sells Treasury bonds on the open market, which means that government debt is purchased by the public. If the Fed buys Treasury bonds from the Treasury itself, the Fed is essentially printing money for the Treasury to use. This is a practice known as monetizing the debt, and it is associated with countries such as Zimbabwe, Argentina and the Weimar Republic.
I am withholding judgment on whether this is a wise practice - perhaps we should just outright create a national bank and let the commercial banks fail - but whether it's good or bad, it's happening, and since the ramifications are so widespread, you need to know about it.
Write to Neal at necoleman@bsu.edu
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