Q.E… Just an “asset swap” as suggested by MMT supporters?

Following on from my last post What People Still Get Wrong About QE…

I have seen MMT proponents suggest that QE is just an “asset swap” with private banks and so no new money is created in the process. In the UK where the central bank purchases bonds mainly from non-banks it is very blatantly false. In order for a central bank to buy bonds from a pension fund the central bank has to give freshly created reserves to the private bank that the pension fund has an account with. That private bank has to then credit the pension fund with the same amount of freshly created demand deposits. These demand deposits did not exist before and constitute new (“cheque book”) money, spendable in the real economy.

In the US where the central bank may buy the majority of bonds from private banks the issue is more complicated because the money creation is more of a side effect of ongoing QE. I emphasize ongoing because in the very *first* instance there may not be any (“cheque book”) money creation. Let me tell it in “cartoon” form for the sake of simplicity. Imagine it’s November 2008 and Ben Bernanke wants to do some QE for the first time ever. He goes round to a private bank, knocks on the door and says “Have you got any government bonds in stock, I’d like to buy some”. The bank has a few and swaps those bonds for reserves and no new cheque book money is created. This is the “asset swap”, just as the MMTers suggest. But then, just as Ben is heading out the door, he turns round and says “it’s a shame you had so few bonds, I’d actually like to buy tons more next month and indeed every month for the foreseeable future”. So the bank manager says to himself, “gee, we’d better get out there and buy a ton of bonds from pension funds and the like so we can sell them to Ben the next time he calls round”… this is where it gets interesting…

The thing is that when private banks buy things from non-banks, new money that never existed before is created… “WHAT!!??” I hear you ask. Yes, indeed. And this fact is not even controversial, it’s just very little known outside of banking. Just think about what a private bank can use to buy stuff. It cannot buy stuff from non-banks with reserves. Instead it simply creates demand deposits for the non-bank. It creates the demand deposits out of thin air, it does not get them from somebody else’s account. So QE does indeed create new cheque book money, but it’s indirect. The new money is created by the private banks when they are expecting to be able to sell bonds to the central bank as part of ongoing QE.