You might have read about quantitative easing (which has nothing to do with Rick Santorum and a speculum) which is when the Fed buys long-term assets (e.g., long-term Treasury bonds) in an attempt to lower long-term bond yields. This is thought to help boost the economy in two ways. First, lower long-term interest rates make it less likely for banks to put money in long-term securities. Second, banks will have more cash reserves after selling these assets. The hope is that, with these additional reserves, banks will be tempted to make more loans, thereby stimulating the economy (yes, I’m oversimplifying and leaving out jargon that is inaccessible to humans).
One of the key assumptions of this policy is that banks aren’t lending because they’re short on reserves (which really could be the case once you take into account all of the shitty loans they’re carrying, but who knows if that’s the case?). That is, banks need more deposits before they will make more loans. That typically isn’t the case, unless the central bank decides to cut the bank off.
In an article that’s mostly another mea culpa by a recovering banker, we stumble across this little bit of economic natural history:
“I was in treasury. Outsiders have this idea that banks take on deposits and then they go and look for a way to lend them out again, making a margin in the process. In reality it’s the other way around. Banks embark on projects for which they need money, and they find it with banks that take on deposits. The process is what we call ‘asset-driven’.
“At the end of each day there will always be banks with money left on their books, and banks that are short of money. Everyone needs to balance out and supply and demand meet in the short-term market for money. This is where banks lend and borrow from each other. I was working in that. I was benefiting from the banks’ practices.
There will be reducto ad absurdum cases, such as a bank with virtually no reserves trying to get money to cover ridiculous amounts of loans, where this obviously isn’t the case (no private banker would take the risk, and central banks wouldn’t want to support wild-ass speculation); here, the bank would be taken over. But it really does seem that, day to day, banks are operationally limited by loan opportunities, not reserves. And don’t just believe me: central bankers have been saying this for forty years (and also see here). This doesn’t bode well for quantitative easing as a policy.
The other problem this could create, and anecdotally this might be happening based on talking to small business people I know along with the occasional news article on the subject, is that lines of credit actually become harder to obtain and maintain. As I discussed in this post, banks can view lines of credit as deposits–that is, reserves. And thanks to quantitative easing they don’t need more reserves. Sucks to be a small business, I guess.
It might be better to pay people to do stuff we need, and drive the opportunities for banks to make loans that way.