[cs702]

I'm not sure what you mean by "excess liquidity ends up in assets." Keep in mind that asset prices are set at each instant by the marginal buyer and the marginal seller. If someone buys a single share of, say, TSLA for twice its most recently quoted price, the market cap of TSLA would instantly double (until the next trade is executed). Prices can rise or drop a lot, even if little money trades hands.

If you're asking how the net present values of long-lived assets change as a consequence of quantitative easing, the answer lies in the impact of quantitative easing on long-term interest rates. All else being equal, when long-term interest rates rise, net present values decline; when long-term interest rates decline, net present values increase.[a]

For example, when the Fed engaged in quantitative easing from 2008 to 2022, it did so expressly with the intention of reducing long-term interest rates. Since last year, the Fed has been engaged in quantitative tightening (selling bonds or letting them mature) expressly with the intention of pushing long-term interest rates up.

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[a] Asset prices (market caps) eventually tend to follow net present values, usually in fits and starts.

EDIT: Changed 1998 to 2008 (typo).

[delaaxe]

I’m asking a practical question, not broad economic theories (which are mostly bs).

How does newly created money (which first goes in commercial bank reserves) finally ends being used to buy houses and stocks?

[somewhereoutth]

Commercial banks actually create the money (by issuing loans) that is used to buy houses (mortgages) and stocks (leverage).

Central banks affect this process by adjusting the rate to which they lend to the commercial banks, and by quantitative easing /tightening which has a similar effect on long term rates.

Rates are low, more loan value is issued (because the income stream servicing the loan translates into a larger loan amount), asset prices go up. And conversely.

[mrcode007]

This is the correct answer.

[cs702]

The same way previously created money ends up being used for anything in the private sector: by the actions of individuals, businesses, and non-governmental organizations. If money is cheaper to borrow, they may choose to borrow more, or take on more risk, or what have you.

But money does not "go into assets." That's a misconception. Money trades hands: For every buyer of a house there is a corresponding seller, and for every buyer of a share of stock there is a corresponding seller. Asset prices can rise, or fall, with each trade.

[CraigJPerry]

>> But money does not "go into assets." That's a misconception

How would you describe the situation when you purchase a treasury bill then?

You gave money, the money you gave ceased to exist in the economy - it is no longer available for anyone to spend, you gained an asset.

[cs702]

> How would you describe the situation when you purchase a treasury bill then?

Your cash (i.e., money) goes to the seller of the treasury bill.

If the seller is a private investor, your cash goes to the private investor (e.g., a mutual fund, a pension plan, an individual).

If the seller is the US Treasury (i.e., you bought a newly issued treasury bill), your cash goes to the US Treasury, which will deposit it, and later on, will use it to pay for the federal government's expenses, including bond interest. (Recall that, unlike the Fed, the Treasury cannot issue newly created money. The Treasury must borrow or collect taxes from the private sector to fund federal spending.)

If the seller is the Fed (through one of its primary dealers, acting as an intermediary), the trade is quantitative tightening.

[CraigJPerry]

>> If the seller is a private investor

This case is not of interest

>> If the seller is the US Treasury

This case IS of interest

>> Recall that, unlike the Fed, the Treasury cannot issue newly created money

This is where it begins to unravel and fall apart. What you say is true in theory only, it’s not true in practice:

The fed finances the primary dealer banks that participate in treasuries auctions - it accepts treasuries as collateral for repos.

The primary dealer banks are obligated to stand ready to purchase treasuries and the Federal Reserve ensures there are sufficient reserves to do so by supplying them through temporary repos (a matched purchase of Treasury debt with a requirement that the seller must repurchase later). While the Federal Reserve is not in that case directly buying the new issue directly from the Treasury, it uses the open market purchase to buy an existing bond in order to provide reserves needed for a private bank to buy the new security. The end result is exactly the same as if the central bank had bought directly from the Treasury.

The fed does also buy treasuries (the fed holds around 10% of treasuries issued - https://fred.stlouisfed.org/series/TREAST).

EDIT: moved paragraph for clarity

[zozbot234]

Unless you purchased a treasury bill from the central bank as part of a money-draining operation, the money is still there. Your counterparty has sold a treasury bill and received money for it, that she'll most likely spend elsewhere.

[CraigJPerry]

We’re not talking about the unless case though - as you say the money would still exist in that case.

[zozbot234]

> How does newly created money (which first goes in commercial bank reserves) finally ends being used to buy houses and stocks?

Well, you have some newly created money, whilst the demand for holding money balances (which depends on the price level and the volume of economic activity) stays the same. So what happens is that money is exchanged away like a hot potato until the demand for money balances rises to match the extra created money. In the short run, this is a mixture of higher prices and a higher volume of expected economic activity, both of which would raise asset prices.

[CraigJPerry]

>> you have some newly created money, whilst the demand for holding money balances … stays the same

This is a contradiction. You can’t create money without a demand for it first. In this specific case through the demand for money in exchange for treasuries/MBS/etc.

>> So what happens is that money is exchanged away like a hot potato until the demand for money balances rises to match the extra created money

This view derives from monetarist theory, it’d be fair to say this view enjoys less support today than it did in the past. As with all macro views, it’s primarily BS with perhaps a little bit of truth that may or may not apply in any given real world scenario. Probably not a useful model.

[zozbot234]

> You can’t create money without a demand for it first.

Why not? At the individual level it literally works the same as any purchase of existing assets. In practice, the counterparty of that transaction will probably spend that money in turn on something else that she actually planned to hold.

> This view derives from monetarist theory, it’d be fair to say this view enjoys less support today than it did in the past.

Well, the biggest flaw of monetarist theory is that it treats "the creation of money" as if it was somehow special, whereas what really matters is the product of money and velocity. (Velocity can be seen as a reflection of external changes in the demand for money balances. It also explains how money can seemingly be "created" out of thin air by entities other than the central bank; what we're really seeing in these expanded money measurements is higher velocity for the actual "high-powered" money that the central bank issues.)

[CraigJPerry]

> You can’t create money without a demand for it first

>> Why not?

To be clear i’m discounting stimulus checks which would be exactly that but it wouldn’t be right to claim this is a common source of money creation.

The most common source would be A commercial bank issues a loan creating new money, but without a customer demanding a loan, there is no ability to create money.

The second most common source would be the government spends into the economy by consuming on its own behalf - there needs to be something for sale in the economy (inc. labour / public sector employment).

[zozbot234]

Usually new money is created when the central bank issues it in exchange for government bonds. It's practically always possible to do this. You could posit a theoretical situation where government bonds are literally indistinguishable from money, but that just means that government bonds are money, so the government treasury has merged into the central bank. Then the central bank has to buy something else, which means it incurs some risk. Or the government can issue more government bonds. "Spending money in the economy" is like this, assuming that the government bonds are permanently rolled over, and never bought back in full.

[vinyl7]

The economy is always inflationary. Money today is worth less than it is tomorrow. Money that the bank has is just rotting away, becoming less valuable over time. Banks need to take the cash they have and invest it in something to offset the inflationary losses. Because bonds weren't paying much interest, it was a better return for the bank to loan out the money for mortgages, investors, etc. Eventually those loans become a part of someone's paycheck or into their bank account (ie home sale that ended up with a 2-300% return). Compared to the bank buying bonds which essentially removes money from the economy.

[zie]

Deflation exists, the US Federal Reserve has a 1 page article about it here, in case you need proof for some reason: https://files.stlouisfed.org/files/htdocs/publications/es/10...

Otherwise, your comment is like grade school levels of understanding of how this all works. Modern banks have the ability to create money.