Who has a better money printer: Reza Baqir or J Powell?
Not all increases in central bank reserves are created equal.
This is a geeky post. It won’t help you to decide kis ka koonda hua hai.
The idea of this substack came when Uzair tweeted the following.
There were these lines in the article
Now introduce a new step into the thought experiment. The central bank, implementing QE, creates new money with which it buys the bonds that the government has given out. So when you net off everything, the government is not giving out bonds, it is giving out cash.
Did the Economist really say that QE is similar to giving out cash?
To be fair, it was a thought experiment in The Economist and the above statement may not be central to the argument. I am just using it as an excuse to write this post.
Comparing QE with Quasi Fiscal Activities (QFAs) will help elucidate both QE and QFA. If you aren’t familiar with QFAs, I suggest the below post, which provides a good primer on the topic.
Quantitative Easing is a form of monetary policy where the central bank purchases long-term securities from the open market against newly created bank reserves. I am using HBL as a stand-in for commercial banks, as writing commercial bank in T-accounts was taking a lot of space.
QE
When the central bank purchases the securities, the balance sheet size of the central bank increases. The central bank does this by crediting the reserve account of HBL with a click of the button (creating money out of thin air). On the commercial banks’ balance sheet, one asset (T-bill securities) gets swapped with the other (reserves with the central bank). (click on the below image to enlarge).
Usually, QE actions are undertaken during recessions when banks are worried about the defaults of the borrowers and aren’t lending on account of uncertainty in the market. As a result, unless the commercial banks decide to lend to the borrowers again, this is just bloating the balance sheet of the financial sector without the funds making their way to the real sector. The money supply may be increasing if we are counting the reserves, but no “cash” is making its way into the real economy.
QFA
Now let’s look at the example of QFAs. State Bank of Pakistan announced TERF facility where SBP will be refinancing commercial banks’ loans to the private sector at 1%. The private sector is getting charged a maximum rate of 5%. The banks will be making a maximum spread of 4%.
Due to the attractive rate of financing, private sector borrowers are approaching commercial banks for loans. The commercial bank offers the loan to private sector and then refinances it with SBP. SBP refinances the loan with a click of the button, i.e., crediting the reserve account of HBL.
Similar to QE, the size of central bank balance sheet increased in QFA. However, unlike QE, the size of commercial bank balance sheet also increased in QFA, and actual cash made its way into the real sector.
Thus, it is Reza Baqir who is running a money printer with his QFAs i.e., TERF, RFCC and other similar programs. Jay Powell is only engaged in asset swap in the name of QE. Reza Baqir is THE king. (click on the video for sound)
Not all increases in central bank reserves are created equal.
In the specific example I have used above, it appears that QFAs are better than QEs. With QFAs, the size of the central bank balance sheet increases only when the money is making its way to the real sector.
Like the Economist’s thought experiments, it was a simplistic example and assumes that in case of QE, commercial banks will be satisfied earning what little interest Federal Reserve pays as Interest on Excess Reserves (IOER). Consider that in US, the rate are near zero, IOER may be enough for the banks to not push the loans to the real sector.
This post was more for clarifying my own thinking. It doesn’t mean QFA is better than QE. Depends on what the central bank is trying to achieve. Thank you for reading it this far.