Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

More questions on QE

Question from Rick Cosier

Warren, thank you for attempting to explain QE, but I don’t really understand it. Perhaps you can enlighten me a bit more.

You mention that the Fed is selling bonds to the market. Who exactly is ‘the market’, when do the bonds mature and what interest rates are involved? When the Fed purchases longer dated bonds later, who do they buy them from and at what price? The impression is that the Fed is supplying money to ‘the market’ for next to nothing, and ‘the market’ invests the money back into US bonds thereby making a tidy arbitrage with absolutely no risk. Consequently, very little of the money is actually being lent to bone fide ‘real world’ investors, which is doing nothing to stimulate the economy.

Furthermore, US debt levels total trillions of dollars which equates to a stratospheric percentage of GDP never before seen. Can you tell me how the central banks expect to repay this debt? Is there a plan, or are they just hoping everything will turn out all right?

Reply from Warren Bird

Hi Rick,

"The market" is anyone who owns Treasury bonds or the other assets that the Fed purchases. The Fed deals directly with a group of banks, but those banks could be selling to the Fed bonds they own themselves, or broking a sale on behalf of their clients who are happy to sell from their holdings.

(This is similar to when a fund manager wants to buy bonds for their portfolio. They go to a bank to do a deal; that bank might sell from their own inventory or they might go to other counterparties to get them. The process of having intermediaries such as the banks is what brings all the different buyers and sellers of securities together so that transactions can take place.)

The bonds that the Fed has been purchasing have a variety of maturity dates and have been transacted at many different yields. Over the time the Fed has been doing QE, US bond yields have traded between around 1.4% and 3%. Every month the Fed has bought the amount it wanted to at whatever yield was trading in the market at the time.  For a period in 2011 they also changed the maturity of their holdings by going to the market to sell bonds maturing in less than 3 years and buying bonds with maturities from 6 to 30 years. (This was known as Operation Twist.)

The Fed is not supplying money to the market for next to nothing. It's a commercial transaction. The market has bought bonds from the US Treasury and then sold them to the Fed at the current yield, which is based on all the other billions and billions of transactions in bonds and other interest rate securities every day. Sometimes the holders will have made a short term gain, sometimes they will have made a short term loss.  In all cases they have given up an asset yielding well above the interest rate they are earning on the cash that they get paid. The point of QE is to get cash into the banks that they can then lend to consumers and businesses.

The idea that the money isn't getting out to 'real world' investors crops up a lot. One thing to understand is that monetary policy - whether it's the 'normal' policy of changing the cash rate like the RBA is still doing, or QE - only ever is a method of persuasion, not coercion. The RBA cuts the cash and hopes/expects that this will result in more borrowing for real economic activity. But if the economy is weak and confidence low, that mightn't be enough and they have to cut again. The judgment the RBA Board makes every month is whether the current level of the cash rate is producing the macroeconomic outcomes they want. If it is, then they say that the current setting is "appropriate". If it isn't, then they change the cash rate.

QE operates when a zero cash rate is proving to be insufficient to generate stronger economic activity. The central banks try to encourage more credit creation by outright bond purchases. But they aren't there to pick the loans to be made, or to force anyone to borrow if they don't want to. They make the liquidity available, try to make yields on longer term borrowing as cheap as possible, and let the real world participants make the ultimate decisions.

In my view it has worked. The Bank of England has estimated that UK economic growth is about 1.5% stronger than it would have been without its QE program. I think the US housing market wouldn't have recovered as strongly as it has without the Fed buying all those mortgage-backed securities, so the US economy has benefited.

It's true that a lot of the cash that the banks have received from their bond sales to the Fed is just sitting in reserves and hasn't been loaned out. That's not necessarily because the banks won't lend, it's because the economy has been deleveraging and borrowers have been reducing their gearing. As I said, monetary policy is only ever able to provide an environment conducive to credit creation, but they can't force the issue.

The Fed has this morning announced a modest tapering of QE, back to $75 billion a month. They've done this because they see signs that the US economy has begun to improve on a more sustainable basis, so it doesn't need quite as much stimulus. Personally I don't believe that this improvement would have happened without QE, so I think it's working. It hasn't worked as fast as everyone would have liked, but that isn't the fault of QE. It is simply a reflection of how bad the underlying economic fundamentals have been and how steep the hill has been up which QE has been pushing. We all hope that the top of the mountain is being reached and that the world can get through this disaster that the GFC has been. But we wouldn't be as close to that point if central banks hadn't run easy monetary policy.

The one thing we do know is that there is now a lot of liquidity that can be put to work when real world agents have investment projects and new businesses to create, and the confidence to borrow to fund them. That is when the money supply will really grow and the Fed will have to be on its toes to reduce the stimulus at the right rate so it doesn't just turn into inflation. It will be a good problem to have, I think.

On your final point, the central banks don't have to repay the debt - the Government does. The central banks have chosen not to merely "print money" because to do so would take away from Governments the discipline of having debt on their books that they have to pay back. As I said in the article the conduct of QE is independent of the size of the budget deficit or the government's total debt level.

Of course, the Fed and other central banks will believe that their governments have a plan to reduce debt levels over time. QE is part of the plan because the best way for governments to get debt down is go support economic growth, which generates the taxes they need in the future to pay their debts. But that is taking us into another huge topic, beyond the scope of this piece.

 

RELATED ARTICLES

Beyond the hype, a beginner’s guide to QE

banner

Most viewed in recent weeks

Australian house prices close in on world record

Sydney is set to become the world’s most expensive city for housing over the next 12 months, a new report shows. Our other major cities aren’t far behind unless there are major changes to improve housing affordability.

The case for the $3 million super tax

The Government's proposed tax has copped a lot of flack though I think it's a reasonable approach to improve the long-term sustainability of superannuation and the retirement income system. Here’s why.

7 examples of how the new super tax will be calculated

You've no doubt heard about Division 296. These case studies show what people at various levels above the $3 million threshold might need to pay the ATO, with examples ranging from under $500 to more than $35,000.

The revolt against Baby Boomer wealth

The $3m super tax could be put down to the Government needing money and the wealthy being easy targets. It’s deeper than that though and this looks at the factors behind the policy and why more taxes on the wealthy are coming.

Meg on SMSFs: Withdrawing assets ahead of the $3m super tax

The super tax has caused an almighty scuffle, but for SMSFs impacted by the proposed tax, a big question remains: what should they do now? Here are ideas for those wanting to withdraw money from their SMSF.

The super tax and the defined benefits scandal

Australia's superannuation inequities date back to poor decisions made by Parliament two decades ago. If super for the wealthy needs resetting, so too does the defined benefits schemes for our public servants.

Latest Updates

Planning

Will young Australians be better off than their parents?

For much of Australia’s history, each new generation has been better off than the last: better jobs and incomes as well as improved living standards. A new report assesses whether this time may be different.

Superannuation

The rubbery numbers behind super tax concessions

In selling the super tax, Labor has repeated Treasury claims of there being $50 billion in super tax concessions annually, mostly flowing to high-income earners. This figure is vastly overstated.

Investment strategies

A steady road to getting rich

The latest lists of Australia’s wealthiest individuals show that while overall wealth has continued to rise, gains by individuals haven't been uniform. Many might have been better off adopting a simpler investment strategy.

Economy

Would a corporate tax cut boost productivity in Australia?

As inflation eases, the Albanese government is switching its focus to lifting Australia’s sluggish productivity. Can corporate tax cuts reboot growth - or are we chasing a theory that doesn’t quite work here?

Are V-shaped market recoveries becoming more frequent?

April’s sharp rebound may feel familiar, but are V-shaped recoveries really more common in the post-COVID world? A look at market history suggests otherwise and hints that a common bias might be skewing perceptions.

Investment strategies

Asset allocation in a world of riskier developed markets

Old distinctions between developed and emerging market bonds no longer hold true. At a time where true diversification matters more than ever, this has big ramifications for the way that portfolios should be constructed.

Investment strategies

Top 5 investment reads

As the July school holiday break nears, here are some investment classics to put onto your reading list. The books offer lessons in investment strategy, financial disasters, and mergers and acquisitions.

Sponsors

Alliances

© 2025 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. To the extent any content is general advice, it has been prepared for clients of Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), without reference to your financial objectives, situation or needs. For more information refer to our Financial Services Guide. You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.