How QE Reserves Circulate Through the Banking System
Summary
The document asks how quantitative easing changed the reserve environment, whether banks still need to borrow overnight federal funds, and why they would hold reserves rather than other assets. The response presents QE as adding digital money to the financial system when the central bank purchases bonds. It describes several destinations for that money: buying securities or other assets, depositing or lending through banks with or without direct central-bank access, entering repo transactions, or leaving funds at the central bank.
The answer’s central idea is that most transactions transfer reserve balances among parties, while balances held at the central bank remain there. However, it does not directly explain reserve requirements, the mechanics of federal funds borrowing, or how interest on reserves affects a bank’s asset choices. Its claim that created money ultimately cycles back to the central bank is an oversimplified account of how QE and reserve balances work. The response offers no evidence or quantitative analysis, so it is best read as a sketch of possible balance-sheet flows rather than a complete explanation of post-QE money markets.
Key ideas
- QE bond purchases increase reserve balances in the banking system.
- The response lists asset purchases, bank deposits and loans, repo activity, and central-bank deposits as possible uses or destinations for funds.
- Transfers among parties can move balances without removing them from the banking system.
- The answer does not directly resolve why banks borrow federal funds or how interest on reserves shapes decisions.
- Its account of reserve balances cycling back to the central bank is incomplete.
Tags
Full text
# Fed fund market after QE # Fed fund market after QE I read that before 2008, reserves of the banking system (vault cash and reserves at the Fed) fluctuated between \$40 billion and \$80 billion. However, as a result of quantitative easing, reserves exceeded \$2.5 trillion over the next 5 years. With such an increase in the magnitude of the reserves, one would think that every bank has excess reserves nowadays, so do banks still borrow Fed funds in the overnight market? It seems one would guess no bank is ever short of reserve with that much reserve in the banking system. Does it still happen that a bank's reserve falls short of the required reserve ratio? In addition, why would a bank be willing to hold so much reserves at the Fed? Since the reserves is increased through open market operations, can't a bank simply hold on to government securities instead of agreeing selling them to Fed in exchange for reserves? Is it just because the interest paid on reserves? What if a bank can use that asset to generate a higher return than the low interest rate on reserves? I am hoping to get some clarifications on my confusions. ## Answer by Attack68 (score 2) https://quant.stackexchange.com/a/61487 When the central bank conducts QE they create money, specifically digital money. That digital money must be accounted for and that means it has to be passed back to the central bank for correct balance sheet accounting. Whomever the central bank buys those bonds from will have (digital) cash at hand. This cash will then be used for one of the following 5 purposes: - buying another security (or currency / commodity) - depositing/lending to a banking institution with direct access to the central bank - depositing/lending to a banking institution with no direct access to the central bank. - engaging a repo transactions (collateralised lending) - depositing with the central bank Any action that is not the last one just passes the digital cash to another party who must again perform one of the 5 actions. This continues until all monies created under QE are treated as option 5. The digital money is passed back to the central bank and balance sheet is square.
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