# Does quantitative easing favour banks?

The reserve bank recently announced it would print $100B over 6 months, and spend this buying back gov bonds. • Will this policy advantage the financial sector over other parts of the economy? • Why doesn't the reserve bank give this \$100B to treasury directly, so that fewer bonds need be issued to support gov spending?
• Alternatively, why doesn't the reserve bank distribute this \$100B directly to ordinary households (e.g. \$4k per resident)?

Will this policy advantage the financial sector over other parts of the economy?

I do not see how this would a priori advantage the financial sector over other parts of the economy. This policy is done to stimulate economic activity by putting pressure on lowering the long-term interest rates and to push pressure on inflation and lower exchange rate. Such expansionary monetary policy is conventionally considered to stimulate real economic activity in the short-run (see any undergraduate macro textbook for example Blanchard et al. Macroeconomics: a European Perspective). There is no reason to a priori think this specially advantages banks over other sectors, as this is macroeconomic policy with aim to stimulate the whole economy, although banks will likely benefit as well.

Why doesn't the reserve bank give this $100B to treasury directly, so that fewer bonds need be issued to support gov spending? This is for several reasons. First, giving money directly to government would mean that money supply is permanently being increased by that new money (technically that money could be still destroyed in some ways but not unliterary just by central bank). When central bank buys government bonds the money supply is expanded only as long as the government bonds are not repaid. Central banks still have option of scrapping the bonds and hence making the money supply expansion permanent, but they also have other options. Central banks will usually want to expand money supply in recession but in expansions they might want to contract it. They could contract it also with other ways (like increasing reserve rations), but open market operations are usually one of the preferred tools of central banks. However, this does not affect government budget negatively. Any interest that government pays to central bank is then returned to the government. So from the perspective of government this debt has no cost. In fact such extra demand on government bonds will likely make it cheaper for government to issue bonds on primary market so if anything it might indirectly help it. Also, the reason why it is done on secondary market rather than primary market, is that central bank is supposed to be independent from government. Hence they try to always keep arms length relationship with it. Alternatively, why doesn't the reserve bank distribute this$100B directly to ordinary households (e.g. \\$4k per resident)?

This is what is called 'helicopter money'. Some economists are in favor of such policy, however arguments are being made that it threatens central bank independence. Helicopter money is very close to fiscal policy and if people learn they could get 'free money' from central bank they might put political pressures on central banks being involved in such transfers beyond what is warranted by monetary policy. It is argued that any fiscal policy should be done by elected representatives and not by unelected technocrats, and helicopter money is very fiscal-esque. See more on this in Reichlin; Turner; Woodford (23 September 2019). Central bank independence is in economic profession revered in similar way as in law profession independent judiciary or in journalism independent press so anything that threatens central bank independence is hard sell. Of course, this raises additional question of why the central bank independence is so important - exploring that is beyond the scope of this answer but you can read more about it in this ECB explainer. In addition in most countries this would not even be legal although laws can be changed.

Edit:

Theory above aside, even when we look empirically at aggregate measures of bank profitability we can see that in the post 2007 they are low, as you can see from the figure below which plots price-to-book ratio for banks, which is a measure of profitability and expected profitability that stock prices capture (see Carletti, Claessens, Fatás, Vives 18 June 2020, and sources cited therein).

QE was not common before 2007 and became quite commonplace after, due to the Great Recession. Hence, there is not much evidence to suspect that banks are somehow 'getting rich' out of QE. Furthermore, of course the above is just raw data so it has to be interpreted with caution. One could argue that maybe there are some other factors that depress bank profitability inspite of all the QE.

However, when we look at some serious research it actually confirms that QE together with negative interest rates and other recent bank regulation erode bank profitability (e.g. see Florian 2018). Hence, if anything there is research and evidence supporting the idea that QE, combined with other policies central banks nowadays commonly pursue, makes banks less profitable not more.

• If the reserve bank wants the power to later unilaterally undo the creation of money, couldn't they still just loan it directly to the treasury, rather than going through commercial intermediaries (who obviously expect a profit margin from each trade they conduct and thereby are posed to gain a benefit from the reserve's activity)? Nov 11 '20 at 22:49
• @benjimin they could but It would be seen as a threat to central bank independence (as addressed in the 3rd paragraph under the 2nd sub-question). Also, the rate on the secondary market affects the rate in the primary market. If traders know with 100% certainty that the central bank is going to purchase some bond for lets say 1100 then they would bid the price on the primary market up to the 1100 - save for a small intermediation margin to cover their cost. This is because if someone offers for that bond just 1090 what stops me to bid 1095? I would still make profit. In equilibrium the price
– 1muflon1
Nov 11 '20 at 23:08
• would be bid up to 1100 (or 1100 - any economic costs for which the trader has to be compensated) Bond market is highly competitive so opportunity for any real economic profit (as opposed to an accounting one) is very small. Only if those traders are willing to take risk there are possibilities for profit ex post but not much ex ante and then it is a reward for their risk taking which should be there. If government would be losing some big money on this then it could be worthwhile to consider having direct purchases of gov debt (although they would first had to be made legal in many places
– 1muflon1
Nov 11 '20 at 23:08
• - I am not sure what laws about this are in Australia) but simply there is no evidence that using secondary market as opposing to primary market would incur significant costs or even affect wealth inequality. In fact many bonds are held by pension funds and insurance companies that need some safe securities. These are services that rich use relatively less. Hence, If monetary policy affects negatively inequality it would be through inflation of stock prices which are mostly (but not entirely) held by upper income classes, but that happens indirectly and not much can be done about that by CB.
– 1muflon1
Nov 11 '20 at 23:09
• Moreover, central bank independence is very important. Historically political meddling in monetary policy was virtually just one disaster after another. Even if there would be some non-trivial costs to OMOs they would have to be big enough to outweigh any possible threat to central bank independence. For example, a simple analogy could be that government could probably save some costs on requiring parliament to also resolve any matters that normally are resolved by supreme court. But saving the trivial cost on the salary for supreme court can easily have more drastic costs for society later
– 1muflon1
Nov 11 '20 at 23:10

Are there viable alternatives to how QE is currently performed?

One goal of the reserve bank's action is to encourage inflation (which has been trending below its targets) and to keep pace with international practice (otherwise domestic producers would be harmed by devaluation of other currencies relative to theirs). But it seems that printing money would still have this effect regardless of where that money is initially spent.

Another goal is to reduce market interest rates, by inflating the price of bonds (reducing the comparative attractiveness of their remaining yield). However it seems like the same effect could be achieved by reducing the supply of bonds rather than augmenting demand (i.e. by cancelling gov debt directly without involving commercial intermediaries). Similarly, the alternative of distributing that money to households ought increase the average level of household net savings and thereby increase bank demand for investments.

Is any sector advantaged by the choice?

In principle some economic stimulus benefit of any spending may trickle throughout the economy, but obviously the most concentrated benefits flow to wherever it is spent first. In other words, the primary beneficiaries appear to be the large financial corporations. This is because (unlike ordinary households) they already own bonds (which will be artificially boosted in value) and their business is trading bonds (which will have a subsidised increase in the volume of profitable transactions). In effect, the convoluted process (of the gov selling bonds and then purchasing them back at a premium) seems to actively concentrate wealth into the financial sector (at the expense of all other holders of net currency).

Presumably this will distort the economy, to prioritise a greater portion of national resources toward the import and production of luxury yachts (for consumption by banking executives). In contrast, I think the social and employment benefits would be larger if the quantitative easing process were modified to directly favour either the public sector (and secondarily the tax base) or all households (and secondarily the broad base of local businesses that supply typical household consumption).

• 1. Mere viability of other alternatives does no answer why central banks do open market operations (OMOs), so the first part does not attempt to answer the Q. 2. banks cannot make consistent riskless profit by purchasing bonds from gov and selling them to central bank. The primary market price already prices in expectations of future price changes at sec. mark. So there is generally no possibility of any sustained arbitrage unless you have evidence for some insider trading (which is illegal). 3. CB does not stimulate economy by inflating bond prices. It does that through interest rates
– 1muflon1
Nov 11 '20 at 12:36
• which encourage borrowing and consumer spending as well as solving issues of nominal rigidities by effects on general price level etc. 4. can you please provide any scientific evidence or reference to some peer reviewed work for claim that OMOs having a tendency "to actively concentrate wealth into the financial sector"? 5. Can you please cite any scientific evidence/paper that would suggest that OMOs distort economy in a way where "a greater portion of national resources toward the import and production of luxury yachts" or heck just any luxury products in general?
– 1muflon1
Nov 11 '20 at 12:36
• expansionary monetary policy does not boost imports it depresses them. Also, monetary expansion leads to inflation which redistributes wealth from lenders to borrowers not the other way around. Nov 11 '20 at 18:20