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The beginning of the end of QE?

JP Dumas

Wednesday, June 8, 2022



If Mme Lagarde is serious about stopping QE (ECB’s bond-buying), this will be the beginning of the end of QE or the beginning of quantitative tightening (QT). When the central bank (CB) is buying bonds to governments, it automatically transforms this government’s debt as a grant. The CB buys the Treasury bonds to banks by creating reserves. The governments’ debt is shifting from the financial sector to the central bank (CB), governments will service their debt to the CB (no more to the banking system); but the CB is owned by the governments. “The government pays interest to the CB which now holds the bonds, but the CB returns this interest revenue to the government.” P. de Grawe. The CB pays back interest payments through the profit it distributes to their governments (profit arising from the creation of money); therefore the payment of interest by governments is reimbursed by the CB when it practiced QE. Regarding the amortization of the debt by governments, it is also free for them, since the CB recycles automatically the bonds coming due. Therefore, QE is a free lunch for governments.


Now if the ECB is serious about stopping bond buying (not yet done), the governments will have to sell their bonds to the financial markets and here we will see the coming back of bond vigilantes. This will mark the return of market forces, no more artificial interest rates at 3.2% for Italy (debt ratio 151% of GDP). At 1.6% for France (debt ratio 112%). Governments will have to pay the market prices for their “whatever it takes” fiscal policy.


It seems to me that QT has two phases, first phase, the CB stops recycling TB coming to maturity. The second phase, which is today excluded, the CB sells the bonds it holds on the market to reduce liquidity (through a reduction of money base). This will have the effect of an atomic bomb on the market, so it will not happen.


The way to reduce the governments’ debt burden will not be anymore QE but through inflation tax. The higher inflation will reduce the debt ratio through r-g higher than the primary deficit if r is negative. The inflation tax will be paid by investors and savers.


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