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delaaxe | 3 years ago

Explaining the mechanics of central banks isn’t as informative as explaining through which specific channels this excess liquidity ends up in assets.

discuss

order

cs702|3 years ago

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|3 years ago

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?

bigcloud1299|3 years ago

This is a very valid question. Up until 2018 or so the liquidity was provided to banks which in turn controlled how much money to loan out. Hence keeping the inflation in check and reducing their risks. however, due to COVID our governments directly handed money to general public through various bills and benefits. That liquidity found its way into other assets. The low mortgage rates pushed housing markets to new highs increase by 100%-200% further increasing net worth of millions who in turn are spending more (wealth effect) further fueling inflation. Now how do you tame this spending? Only way to do so is to reduce the wealth effect or accept the inflation to be higher than 2% target and admit it will take several years to stop it from increasing.

The Taylor rule is showing that the interest rates should be over 10%.