Knowledge popularization: You may have misunderstood QE

This time I want to popularize a word that everyone is very familiar with, but most people may not have thought carefully about the meaning behind this word. That is QE. I didn't think there was anything to say before. We have been talking about it for many years, and everyone should know it well, but later found out that it doesn't seem to be the case. Many people have many misunderstandings about the term quantitative easing.

QE is also called LSAP or this is the correct name, translated as asset purchase plan. Many materials on the official website of the Federal Reserve use LSAP to express quantitative easing. Of course, it is not impossible if you have to call QE.

How is quantitative easing implemented? First of all, we must make it clear that quantitative easing involves the expansion of the central bank's balance sheet, that is, additional currency issuance, but this additional issuance does not involve printing money. It simply records a number on the account, which expands the balance sheet.

How does the central bank expand its balance sheet?

The process of asset expansion starts with the central bank buying treasury bonds or other types of assets. For example, if you buy a national debt, you have to pay others, right? So where does this money come from? This money is created out of thin air, and it corresponds to the expansion of liabilities. Central banks acquire assets by paying reserve deposits.

Reserve deposits are liabilities of the central bank. How do you understand this?

That is, the money you deposit in the bank is the bank's liability to you. Then the reserve deposit is the money that the bank deposits in the central bank, which is the liability of the central bank to the bank.

If the bank is the seller, it is equivalent to the central bank owes the bank a deposit, then the central bank will pay the bank a reserve deposit to buy the bank's debt.

If the seller is an individual, for example, if my debt is sold to the central bank, then the central bank will also transfer the money to a bank. Why?

Because that bank is collecting money on my behalf. After the bank gets the money from the Federal Reserve (reserve deposit), it will record a deposit of the same amount in my account, which is equivalent to the bank acting as my financial intermediary and completing the entire payment.

This is how central bank balance sheets expand.

The essence of QE

Because what you bought was treasury bonds, in fact there is no additional issuance of debts, why do you say that?

Because the purchased treasury bonds are assets in circulation that have been issued before, and financing activities have been completed, so it does not involve additional issuance. Therefore, quantitative easing does not actually involve the addition of new assets and liabilities in the market. It just buys the stock assets in the market and converts them into currency.

For the central bank, this is actually a currency issuance. Because the stock assets in the market are converted into currency, and the assets are withdrawn from circulation at the same time, the national debt in the market will decrease.

For the central bank, it is an expansion of the balance sheet, and then absorbs part of the assets into its own balance sheet.

Then, for those parties who sell assets, they have actually completed asset replacement, that is, asset a has been exchanged for asset b.

For example, when you hold treasury bonds, it is a claim on the US Treasury; and when you sell it, it becomes a claim on the central bank.

Why implement QE?

There are two benefits in theory. The first is the improvement of liquidity, which is easy to understand. I bought your assets, and you have an extra sum of money in your hand. You can use this money to do many things.

The second is the so-called portfolio rebalancing, which is also the transmission mechanism that former Federal Reserve Chairman Bernanke has been talking about. I bought your national debt, which is a kind of safe asset, and the less and less safe assets you buy, there will be no safe assets for you to buy in the market, which will increase your risk appetite, buy some junk bonds, buy some Corporate bonds and the like mean that your money will flow to assets with higher risks. This is portfolio rebalancing.

The purpose of this is to allow you to pursue high-risk assets instead of putting money on safe assets.