Monetization, Pure and Simple

The deception, with tact
Just what are you trying to say?
--The Fixx

When it wants to employ 'monetary policy' to stimulate economic activity, the Federal Reserve can choose from three primary approaches. All three involve the creation money out of thin air (i.e., 'money printing'). However, the dynamics differ depending on the approach employed.

The most popular approach to date has been to lower the interest rate charged to banks that want to borrow funds from the Fed. All else equal, the lower the cost of borrowing money, the more money that will be borrowed. Presumably, banks would then use those borrowed funds to engage in lending, investing, and other activities that would stimulate the economy. The funds that the Fed lends are sourced out of thin air. The catch, however, is that this form of money, sometimes referred to as 'credit money,' is not free and clear. It is not like receiving a $100 bill as a gift. Instead, it is like taking out a $100 loan. The loan is a liability. You can spend the $100, but you must pay it back in the future--with interest at the rate specified by the Fed. As such, credit money created is subsequently 'destroyed' when the loan is paid back. Credit money can therefore be seen as temporary in nature. When credit contracts, so does the supply of credit money.

A second approach is to simply send checks directly to the people. This is the 'helicopter money' idea famously elaborated by former Fed chair Ben Bernanke. To date, the Fed has rarely used this approach, although central banks elsewhere have engaged in goodly amounts of helicopter money--often to the visible detriment of the monetary system (e.g., Weimar Germany, Zimbabwe, Venezuela). A recent example on a small scale here in the US was the 'tax rebate' checks sent to people in attempts to stimulate the economy during the 2008 credit collapse (a collapse which, by definition, destroyed lots of credit money discussed above). Imagine this on a larger scale, e.g., $50,000 checks sent to every US citizen every month, to get a sense of big league helicopter money.

The third approach, one that has gained recent popularity, is monetization. Monetization is where the Fed creates money out of thin air to buy assets. The Fed's three 'quantitative easing' programs (QE1, QE2, QE3) programs were large-scale monetization schemes. From 2008-2015, the Fed bought nearly $4 trillion of Treasury, agency, and other debt from bond dealers. The Fed put those assets on its balance sheet. In exchange, bond dealers got $4 trillion of freshly minted cash. How might this stimulate economic activity? The thought was that, in addition to the direct effect of putting money in bond dealers' pockets (which could be used for investment or consumption purposes), interest rates would also be pulled down by the bond buying (when bond prices go up, bond yields come down). Lower rates, as noted above, should stimulate borrowing all else equal.

Other central banks followed the Fed's lead and established their own flavors of QE-style monetization. Currently, the Bank of Japan and European Central Bank operate QE programs that dwarf the $4 trillion Fed project.

Last week, the Fed announced that, after a four year respite, it will once again buy assets. This time the focus will be on shorter duration Treasuries. The central bank adamantly denies that this is QE, but this is a semantic smokescreen.

Bond buying, whatever the duration and for whatever reason, is monetization, pure and simple.