QE meant that the monetary base increased dramatically, yet we don't see such a large reaction in money supply (I am thinking of M4 for the UK) nor in inflation. Why is this money not being lent out? Are banks keeping large excess reserves for fear of a crash?

I know this is a quite common question but I still don't understand what the accepted answer is here.


According to Gambacorta and Mizen (2019) a number of factors explain the 2008 crisis (and insofar post-crisis) multiplier:

  • banks factor in may more things than the interest rate nowadays, of their own accord

  • they are also obligated to comply with more regulatory oversight

Before the global financial crisis, the world was a simpler and more innocent place [...]. Although there were many risks that had not been properly priced into funding costs for banks, lending was funded at the margin in relation to short-term market rates that closely followed policy rates. Since then, that innocence has been lost, and funding costs reflect a range of risks that were small and largely ignored previously. The academic work on interest-rate pass-through reflects this more complex environment, allowing for a blend of funding sources that combine to give information on the cost of bank funding, which can often depart from policy rates by some margin. New channels of transmission have been developed to reflect the bank lending, bank capital, and risk-taking channels, which take on greater significance in the postcrisis world. Similarly, since monetary policy has been conducted using FG [forward guidance], the impact has been on future rather than current financial-market conditions requiring models that allow banks to form forecasts of future funding costs. Unconventional policies relying on liquidity operations, asset purchases, and conditional lending schemes have influenced long-term rates of interest rather than overnight rates, and new approaches have been developed to consider the effects of these policies on banks. Despite many concerns about the weakening of monetary transmission, the results of these new developments have pointed to a strong and robust relationship between policy measures and the retail rates that affect households and firms. In this respect, central banks can be reassured that the innovations in the making of monetary policy in the postcrisis era have proven effective in maintaining control over lending and deposit rates.

What can we expect in the future for interest-rate pass-through and monetary transmission? Institutional change is under way, as part of the process that aims to avoid a repeat of the crisis in 2007–2008. Banks are now regulated to a greater degree, and liquidity and capital buffers are mandated to avoid dangers of illiquidity and insolvency among individual banks spilling over into the banking system as a whole. The Basel Committee on Banking Supervision will introduce reforms in the form of Basel III to strengthen the regulation, supervision, and risk management of the banking sector. These measures aim to improve the banking sector’s ability to absorb shocks arising from financial and economic stress, whatever the source, to improve risk management and governance of banks and strengthen banks’ transparency and disclosures. Microprudential regulation will help raise the resilience of individual banking institutions to periods of stress, while macroprudential regulation will reduce system-wide risks that can build up across the banking sector as well as the procyclical amplification of these risks over time. These changes will increase the cost of certain types of funding and at the same time reduce the risks associated with banks, which may reduce the costs of others.

A number of empirical studies are cited in support, mostly from the EU, e.g.

  • Banerjee, A., V. Bystrov, and P. D. Mizen. 2017. “Structural Factor Analysis of Interest Rate Pass Through in Four Large Euro Area Economies.” Working Papers in Economics 17/07, University of Canterbury, Department of Economics and Finance.

  • Harimohan, Rashmi, Michael McLeay, and Garry Young. 2016. “Pass-Through of Bank Funding Costs to Lending and Deposit Rates: Lessons from the Financial Crisis.” Bank of England working paper 590.

Identifying the new channels of transmission seems a pretty active area of research.

Rhyan and Whelan (2019) mention that the most influential theory insofar seems to be the "portfolio rebalancing channel":

money multipliers in the US, the UK, and the euro area dropped sharply following the introduction of QE, an outcome which is at odds with the predictions of a textbook money multiplier framework. The QE literature has instead focused mainly on the effect of changes in the net supply of bonds to the private sector in reducing bond yields, i.e. a portfolio rebalancing channel (e.g. Gagnon et al. 2011).

Gagnon et al. (2011) ("The Financial Market Effects of the Federal Reserve's Large-Scale Asset Purchases ") has some 700 citations in Google Scholar. A more recent paper like that from the Euro area is Albertazzi et al., 2018.

Basically QE has rendered the usual crediting done by banks less attractive, so there's a shift ("portfolio rebalance") toward riskier assets/loans. But there's apparently more regulatory limit on those.


You may want to look at the following paper by Cukierman (2017). The author compares inflation for a period of identical base expansion in post Lehman US and hyper-inflationary Germany in the 1920s. They mention exactly what you said, that banks have increased their reserves at the Fed. In the US this has not translated into a heightened demand for goods and services as was the case in Germany. Furthermore the author cites fundamental differences in the economical and institutional circumstances as a reason for the difference in transmission. I suggest reading the paper for a more in depth explanation.

  • $\begingroup$ There's a paper related to that (Lopez and Mitchener, 2018) which analyzes more countries post WWI and concludes that uncertainty was the main factor for hyperinflation $\endgroup$ – Fizz May 30 at 3:00

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