Money Creation: Misconceptions: Quantitative Easing Creates Money

Abstract

There is a profound misconception amongst certain commentators on money and banking: that quantitative easing creates new money. The misconception is either: (1) that new money is injected into the economy; (2) newly created excess reserves can be used by the banks to make new loans. Neither of these is correct. Quantitative easing, that is, the purchase of securities by the central bank from the banks (usually), may lead to money creation (that is the objective of the policy), but it does create money when the purchases are made. The purchases create excess reserves for the banks, and these reserves cannot be loaned by the banks. The only way that the excess reserves can be employed by banks is by making new loans (underlying which lies the objective of the policy: economic activity), which creates new deposits (money), which carries a reserve requirement, thus shifting the dividing line between excess and required reserves in favour of the latter. This process is helped along by the immediate outcome of excess reserve creation: the lowering of interest rates to a level approximating the cost of banking.