Nov 14 7:45 PM

Waiting for the $3 trillion payoff?

Nominee for the Federal Reserve Board Chairman Janet Yellen waits for the beginning of her confirmation hearing November 14, 2013 on Capitol Hill in Washington, DC.
Alex Wong/Getty Images

In the annals of inscrutable banking language, Quantitative Easing or QE will probably go down as one of the most muttered, least understood terms to have come out of the Federal Reserve. Eye-glazing though the subject may be, there’s no ignoring the eye-popping sum of new money the Fed has pumped into the economy since November 2008—roughly $3 trillion and counting—or the fact that two-thirds of it is sitting in the Federal System earning interest for big banks. 


Perhaps the biggest myth surrounding QE is that it’s a money printing program—a misconception that has left many wondering why their wallets aren’t fatter for that $3 trillion. The Fed doesn’t cry “roll the presses” to inject new money into the banking system. It buys Treasury bonds and mortgage-backed security bonds from banks by crediting their accounts at the Federal Reserve with “new” money. Think of it as money created out of thin air that manifests as a number on a balance sheet rather than physical money thrown down on a counter to pay for a morning coffee.

"The policy of paying interest on excess reserves weakens the impact of quantitative easing on the economy, on the willingness to lend and probably should be stopped"

Paul Edelstein, IHS Global Insight


QE is designed to flow into the broader economy by putting banks in a stronger position to lend, but mostly by raising prices of the types of bonds the Fed buys. This lowers long-term interest rates, including mortgage rates, which in theory should put consumers in a better position, not to mention a better frame of mind, to buy things on credit. Consumer spending is the engine of US economic growth, so the more consumers splash out, the more likely businesses are to expand their production and create new jobs to meet that demand. Lowering long-term interest rates also has a positive knock-on-effect to assets like stocks, because when long-term interest rates are low, investors are more likely to seek higher returns in riskier securities.    


How well Quantitative Easing has worked is the subject of fierce debate, though some clear winners have emerged. House prices have rebounded in many parts of the country, but as the St Louis Federal Reserve recently noted, the recovery has been strongest among higher-value houses which are likely to have owners of “above average wealth.” Stocks have also done gangbusters this year—but with only 47% of Americans invested in the stock market, those gains have also left the majority behind. 

“The people who own equity have been doing very well,” says Catherine Mann, a former Federal Reserve economist and now Professor of Finance at Brandeis International Business School. “They have got nice capital gains. They do feel wealthier and they do spend money but it’s a small share of the US economy so it’s not a big enough share to boost the entire economic growth.” 

Economists at the St. Louis Federal Reserve’s Center on Household Financial Stability estimate that the overwhelming majority of American households, 76%, are still struggling to rebuild their wealth in the wake of the Great Recession, while only 24% are thriving financially. The bifurcation begs the question: if the majority of Americans aren’t feeling wealthier from QE, what exactly are all those trillions in “new” money doing?


The majority of the funds created by QE are gathering dust in the Federal Reserve System as excess reserves over and above what commercial banks are required to hold to protect against loan defaults. Excess Reserves of Depository Institutions have exploded from $267 billion in October 2008, to $2.2 trillion in September 2013 (chart below). 

Excess Reserves of Depository Institutions (EXCSRESNS)

“What those excess reserves do is give the banks scope to lend an awful lot more money at some point but so far that hasn’t happened either because banks aren’t willing to lend the money out or because there simply isn’t the demand for the loans that could be created,” explains Paul Ashworth, Chief US Economist at Capital Economics Ltd.  

Either way, the banks don’t have to lend excess reserves to realize a return because the Federal Reserve pays 0.25% interest on them. Paul Edelstein, Director of Financial Economics at IHS Global Insight believes that interest makes QE less effective. “The policy of paying interest on excess reserves weakens the impact of quantitative easing on the economy, on the willingness to lend and probably should be stopped,” he said. 

Brandeis’ Catherine Mann also thinks it’s time for the Fed to stop paying interest on excess reserves. “That would incentivize banks to take it off the Federal Reserve balance sheet and put it back out into the market,” she explained. “It’s not enough for QE to reduce long term interest rates, it’s not enough for the asset channel to be functional. The success of this whole QE policy and the growth of the US economy also depends on a health credit channel.”

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