Because the bonds are short-lived, the Federal Reserve has been adamant that this new bond-buying program is not QE4.
One critical point about QE is not what the Fed is buying but from whom they are buying.
When they purchase treasuries from banks, banks get more reserves per non-event; however, when they buy from a non-bank, the Fed receives a bond (an asset) offset with reserves (a liability). Commercial banks get reserves (an asset) offset by a deposit (an obligation).
That bank deposit is no different than what the seller of the bond would get if they took out a new loan. It injects dollars into the economy because nobody’s bank account gets reduced.
In typical business transactions, the purchaser of a bond or any other financial asset sees their bank account drop by the amount paid. Money moves around but is not created, not so with QE. Because the Fed creates new money, nobody sees their bank account fall by the amount of the purchase.
Reserves and Deposits
This connection between reserves and deposits is, in part, why negative interest rates won’t work. Why would banks create deposits that they may have to pay interest on when the reserves received from the central bank to offset the deposit are subject to a negative interest rate?
Here in the U.S., commercial banks make interest on their excess reserves. And if the interest rate is higher than what they are paying to their depositors, QE leads to higher profits.
Does QE4 Juice the Stock Market?
There is no way to know for sure. Still, when the Fed adds money to the economy by buying bonds from non-banks, the stock market seems to go up. When they subtracted cash from the economy by not reinvesting mortgage payments (quantitative tightening), it went down.
Has the Fed Stumbled upon Continual Economic Growth?
Keep providing money (QE) to the economy by buying assets from nonbanks. As money continues to fund financial assets, labor gets little of it. Does this mean inflation will remain tame? The wealth effect dictates that rising stock prices will result in wealthy investors spending more, causing the economy to grow.
What could possibly go wrong?
These are the opinions of Tim Hayes and not necessarily those of Cambridge Investment Research. They are for informational purposes only, and should not be construed or acted upon as individualized investment advice.