How QE works

Various commentators are saying that Europe’s QE won’t work, or QE in general doesn’t work because it just boosts the value of assets. Increasing the reserves of banks, critics say, doesn’t cause banks to lend money to the real economy.

That’s irrelevant. QE is not supposed to make banks lend more money. Banks don’t need reserves to lend money, or rather it works the other way. Banks lend money if there’s demand for loans, and then ask for reserves which are always given.

What QE does is indeed to boost asset prices. Central banks buy bonds, people who sold the bonds buy stocks, stocks go up in value. Or people who sold the bonds spend money, money ends up in company profits, stocks go up in value.

And this how QE works. What happens when stocks go up in value? Companies expand and hire more people. What happens when stocks fall in value? They cut costs and lay off people. When stocks rise in value pension funds are wealthy. When they fall, poor.

In our imperfect system QE is a blunt instrument that makes rich people richer while boosting the economy. The problem, though, is with concentration of financial wealth, not with QE.

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