Quantitative easing: printing money like mad to ward off deflation

By Edward Harrison, RGE Monitor

In economic circles, there has been a lot of buzz about Quantitative Easing of late.  Basically, the U.S. Federal Reserve has lowered interest rates to near zero percent and the fear is that these cuts will not have enough effect on the willingness to lend in order to reflate the U.S. economy.  Therefore, the Fed has decided to take more draconian measures, one of which is Quantitative Easing, flooding the economy with money.

This experiment is not without risks.  There is the potential for very high inflation down the line if the Fed is successful.  But, does the Fed have a choice?  It seems that it is looking at deflation or depression on the one hand or stagflation on the other.  Take your choice.

But before you take sides, first let me go back a few years in history to describe exactly just what quantitative easing, a policy first really practiced in earnest in Japan, really is.  Wikipedia has an excellent definition.

Quantitative easing was a tool of monetary policy that the Bank of Japan used to fight deflation in the early 2000s.

The BOJ had been maintaining short-term interest rates at close to their minimum attainable zero values since 1999. More recently, the BOJ has also been flooding commercial banks with excess liquidity to promote private lending, leaving commercial banks with large stocks of excess reserves, and therefore little risk of a liquidity shortage.

The BOJ accomplished this by buying much more government bonds than would be required to set the interest rate to zero. It also bought asset-backed securities, equities and extended the terms of its commercial paper purchasing operation.

In essence, the Bank of Japan found that despite lowering short-term interest rates to zero it could not get its zombie banking sector to lend. Credit, the life blood of our fractional reserve banking system, was just not increasing. Therefore, the Bank of Japan began buying Japanese government bonds (JGBs) with money that it created out of thin air — that is they bought existing assets with money that did not previously exist. Central Banks can do this because they control the electronic printing presses. Now, the likes of Murray Rothbard, an Austrian School economists calls this counterfeiting. However, regardless of how you see this, this is how our monetary system works. Read more….