The “Bite-Sized” Tutorial on Quantitative Easing, or (QE)

The central bank issues currency out of thin air.

Commercial banks have a reserve account at the central bank.

The economy could really use a boost. It needs more currency.

The central bank first reduces its target interest rate near zero or to zero. It does this because it is about to build up excess reserves and that could cause interbank competition for excess reserves.

Interbank competition will drive down the overnight rate causing the central bank to lose control of monetary policy.

So, the central bank first reduces its target interest rate near zero or to zero to prevent this problem.

Now, the central bank says, “Let’s do some QE!”

The central bank takes a bond or another asset from a bank and swaps it for currency issued out of thin air.

The currency is deposited in the bank’s reserve account which is held at the central bank. The currency never leaves the reserve account or the central bank.

The reason?

Because banks cannot lend out reserves.

Reserves operate the payments system.

Banks can only lend by creating their own IOU and then denominating that IOU in the government’s currency.

So, the excess reserves just sit there.

No credit expansion.

No inflation.

You’ve done nothing substantial for the economy.

You’ve wasted a lot of time.

Congratulations.