When central banks buy bonds and mortgage-backed securities, doesn’t that add more cash to the financial system? If no inflation results, could they simply buy all the debt? IIRC Germany couldn’t find enough buyers for their 30 year negative yield bonds, so their central bank ended up buying most of them. If that’s possible, why wouldn’t a country want to run up the deficit and fund it via QE?
In: Economics
Scanning through this, no one has provided the actual answer: It’s called **interest on excess reserves** and it is the only reason QE didn’t cause hyperinflation. The reason QE would tend to cause massive inflation is because of the money multiplier effect. QE creates new base money. As you are probably aware, depository institutions such as banks then multiply this base money by accepting deposits and making loans. Adding to the monetary base can quickly expand the money supply and lead to inflation. So while the Fed created a bunch of new base money, it also started paying interest on excess reserves to prevent that inflation.
The Fed has always required banks to keep a portion of their money deposited with it, based on how many deposits they have. In short, every time you deposit a dollar with a bank, a portion of that dollar has to be kept in an account with the Fed. The Fed has always paid interest to banks for the amount they were **required** to deposit with it. After the 2008 crisis, the Fed also began paying interest to **all** deposits banks make with it, not just the required ones. This kept the banks from lending all that new money out, creating new deposits, and expanding the money supply. The result was [this](https://fred.stlouisfed.org/series/EXCSRESNS). Over the past 10 years, banks have kept between $1 and $2.7 trillion deposited with the Fed above and beyond the regulatory requirement…because it’s paying them to keep it there.
This is base money that is just being held out of the economy and you are paying to keep it that way.
This indeed stabilized the banking system, but it also made the Fed’s job much more complex until it can drain away all those excess reserves. Another round of QE is going to be unfortunate, since as you can see from the graph, we had been steadily reducing those reserves since late-2014.
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