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Study: QE is no welfare program for big banks

Federal Reserve Lowers Key Rate By Three Quarters Of A PointFederal Reserve Lowers Key Rate By Three Quarters Of A Point
The Federal Reserve building in Washington, D.C..Photo by Chip Somodevilla—Getty Images

If there’s one thing that both the left and right in America can agree on, it’s that the U.S. government is the thrall of Wall Street, handing out freebies to big banks whenever it gets the chance. And the king of all Wall Street welfare, according to these critics, is quantitative easing. Take, for instance, libertarian magazine Reason excoriation of central bank bond purchases back in 2012, when the current program was announced:

Quantitative easing … is fundamentally a regressive redistribution program that has been boosting wealth for those already engaged in the financial sector or those who already own homes, but passing little along to the rest of the economy.

These sentiments were echoed by left-leaning publications like The Daily Kos, which referred to QE as “corporate welfare” for big banks. But a new study released Wednesday by the International Monetary Fund, which the authors claim is “the first to provide a comprehensive assessment of unconventional monetary policies on the soundness of the banking sector,” argues that quantitative easing likely hurt the profits of banks, if it had any effect at all on their bottom lines.

The paper shows that while the QE program reduced banks funding costs and increased the value of some bank assets it hurt banks’ profitability by lowering the amount of interest these firms could charge on a range of products. The fact that Fed actions to reduce long-term interest rates has led to a flattening of the yield curve has made it particularly difficult for financial institutions to make money when the business of banks, put simply, is borrowing short-term and lending long-term.

On the other side of the coin, however, the IMF study did find that QE has encouraged banks to increase their risk taking because low interest rates make it easy for banks to avoid removing toxic assets on their balance sheets. According to the report’s authors, “When interests rates are very low, banks can rollover existing loans or even extend new loans to nonviable firms at nearly zero cost.”

This makes sense. What is the point of lowering interest rates if not to motivate lenders to take risks they otherwise wouldn’t have taken? If you believe that a central bank ought to manage interests rates and institute policies that balance promoting growth and limiting risk, well, QE is a natural extension of that principle.

The Fed has several tools at its disposal to rein in risk—like its stress tests, the review of large banks’ “living will” plans, and other regulations—so it can accept that QE might increase risk taking as long as it also boosts growth, particularly at a time when there is a lot of slack in the economy.