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My Background I was an Economics major a long time ago and I don't work in a related field. I have this question that's been nagging me. I hope somebody can answer the questions at the bottom.

Background Information During Open Market Operations, the Fed buys or sells Treasuries in order to effect certain desired results such as changing the interest rate or changing the money supply.

To pump more money into the economy, the Fed will buy tons of Treasuries. In other words, banks and other entities will give their Treasury papers to the Fed and in return, the Fed gives cash to the banks. Then, this cash eventually finds its way into the local economy, spurring economic activity.

My Questions

  1. When the Fed sells and buys Treasuries from banks, aren't the banks getting an enormous gift? When I say gift, I mean that it's almost like free money. When the Fed buys Treasuries, it announces what it will do and then buy in massive quantities which will inevitably drive up the value of Treasuries. Banks are now selling their Treasuries for much higher prices than it was just a few days ago. Isn't this a great deal for them? How can they say no?

  2. The second largest beneficiaries of the Fed's purchase of Treasuries aren't the common masses but are the large institutional investors who have a lot of money to begin with. They are suddenly getting loans at extremely attractive rates and terms. Is this preferential treatment (aka gift) very fair? Can't we create a different system of loans so it's not so skewed towards the wealthiest .1%?

I strongly believe that Open Market Operations are absolutely an indispensable tool for the Fed to manage the economy. But, that's not point though. My point is that although it's necessary, doesn't Open Market Operations extremely favor the financially wealthy? Trickle-down economics may work here but history has told us repeatedly that it's not very even-handed. The money that flows to the average American is much less than what the people at the top get.

Is my description of this process correct? Are Open Market Operations a large gift to the banks and the large investors that receive the initial loans?

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  • $\begingroup$ May be relevant: en.wikipedia.org/wiki/People%27s_Quantitative_Easing and en.wikipedia.org/wiki/Helicopter_money $\endgroup$ – Kent Shikama Mar 3 at 20:15
  • $\begingroup$ I've changed the tags from growth to inequality since you don't seem to doubt the former but question the effects (of monetary policy) on the latter. $\endgroup$ – Fizz Mar 3 at 23:28
  • $\begingroup$ This is the topic of the "Innocent Bystanders"-paper : sciencedirect.com/science/article/abs/pii/S0304393217300466 , you can see an earlier NBER - working paper version here: nber.org/papers/w18170.pdf . I cant tell you what the differences between the two are, since I dont have access to Elsevier's publications from home. $\endgroup$ – Grada Gukovic Mar 4 at 1:00
  • $\begingroup$ @GradaGukovic: a paper with a pretty obfuscating summary and conclusions likewise. It seems to be saying that "hitting the zero" bound is equivalent to a contractionary episode, which increases inequality. But it doesn't really seem to say anything about the expansionary phase nor QE. $\endgroup$ – Fizz Mar 4 at 5:13
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Yes they are "gift" (or rather a stimulus), but not exclusively to the 0.1%. There's basically "trickle down" by inflating the M2 money supply, i.e. bank loans, which hopefully include loans to companies where the "average guys" work.

So in theory, banks have more funds to lend, at a low rate of interest, encouraging households and businesses to borrow. [...]

The Bank of England estimates that ultra-low interest rates and QE meant that the average household's income was £9,000 higher than it would have been by 2018.

It argued that younger people actually benefitted most, as they were more likely to be in work and reliant on wages for income.

By contrast, savers, who tend to be older, received negligible return on their money.

It's also true that QE and cheap credit in general have been a boon to the those well off, fueling asset prices (and not just stocks, but also real estate etc.)

But the starkest impact of QE has been on wealth, the value of assets, from housing to pensions.

The money received by financial institutions in return for bonds sometimes got diverted into other investments - bulking up the prices of the value of shares or property, benefiting those already at the top of the tree the most.

Shares in the FTSE 100 index have, on average, more than doubled in value over the past decade. [...]

property prices have risen by 43% over the past decade - far more than they would have done in the absence of the emergency injection of funds.

So they've vastly outpaced earnings growth; buying your first property and moving up has got even harder.

A 30-something today is less likely to own property than their great grandparents.

This is for the UK but the effect of QE and cheap credit have been pretty much the same everywhere.

So yeah, if you want to be a cynical Marxist, you could say QE has created even more "wage slaves" than before, i.e. an increase in wealth inequality in some sense. The ECB hower disagrees with such a conclusion:

Quantitative easing in the euro area through the ECB’s asset purchase programme (APP) has stimulated economic activity and asset prices, affecting income and wealth inequality among households. It has decreased income inequality, mostly by reducing the unemployment rate for poorer households, but also, to a lesser extent, by increasing the wages of the employed. Quantitative easing has also helped to reduce net wealth inequality slightly through its positive impact on house prices.

Meh. There's a more rounded review of the research on the effect of monetary policy on inequality in an open access paper. Basically the effects on inequality seem to be ambiguous or modest at best.

Our review suggests that empirical research on the effects of conventional monetary policy on income and wealth inequality yields mixed findings, although there seems to be a consensus that higher inflation, at least above some threshold, increases inequality. In contrast to common wisdom, conclusions concerning the impact of unconventional monetary policies on inequality are also not clear cut.

And it also features a quote from Bernanke:

the effects of monetary policy on inequality are almost certainly modest and transient. (Bernanke, 2015).

N.B. When you say "trickle down doesn't work" (with respect to inequality), you're probably mixing the jars with the fiscal policy, i.e. tax cuts... which might be good separate question, although it might have been asked here before. Fiscal policy is generally considered the main "tweaking knob" for inequality.

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  • $\begingroup$ I didn't really want to shift the discussion to inequality. I wanted to really learn the specific details of how the Fed increases money supply. I wanted to know if their purchase of Treasuries directly benefits the banks because it's almost like giving them free money to loan. What are the true fundamental benefits and cons to these banks? $\endgroup$ – QuietMontanaNights Mar 4 at 21:45
  • $\begingroup$ @QuietMontanaNights: well, you've ended your question with "doesn't Open Market Operations extremely favor the financially wealthy? Trickle-down economics [...]" If you want to ask about the technical aspects, you're probably better off asking a new question at this point... $\endgroup$ – Fizz Mar 4 at 21:53
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    $\begingroup$ Fizz, it would seem that Open Market Operations is a method to stimulate the economy but a poor one at that. If the Fed's purpose is to increase the money supply, I think there are much better ways to do this without just pumping it into the finance sector. It seems just dumb. If it's the Fed's purpose is to stimulate growth by loaning money, I think that it's has good intent but it really creates an unfair advantage for the larger, established companies. What other choice does the Fed have though? I don't know but it creates a huge advantage for a specific segment of the population. $\endgroup$ – QuietMontanaNights Mar 4 at 22:13
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    $\begingroup$ I think fiscal stimulus is actually an undiscovered way to stimulate the economy by awarding grants in new industries. I admit when government is involved in direct financing, it's extremely dangerous as we saw the federal gov lose a billion dollar investment in that solar company. Also, Obama's fiscal stimulus was admittedly a failure. His economic advisors were in uncharted waters so I will give them a break advising to do things like increase spending in infrastructure. The logic was the many unemployed people in construction could laterally move to infrastructure but it didn't work. $\endgroup$ – QuietMontanaNights Mar 4 at 22:25
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    $\begingroup$ I'm not sure if this is legal but another option would be to simultaneously sell off the Fed's balance sheet and hand out the revenue as helicopter money. $\endgroup$ – Kent Shikama Mar 4 at 22:31

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