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How to adjust quantity of money?

  • Writer: Macroprudential Policy
    Macroprudential Policy
  • Jul 3, 2020
  • 3 min read

Updated: Aug 3


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Leverage tools are more targeted, allow sustainable exit strategies, and minimize public risk exposure.


Central banks turned to quantitative easing after 2008 to overcome the limits of interest rate policy, but QE often inflates asset prices rather than stimulating consumption.


By contrast, leverage tools, such as countercyclical capital buffers or mandated credit expansion, can directly fund consumer spending through bank lending.


Leverage Tools as Alternatives to QE


While QE remains prominent, other quantity-based tools—such as macroprudential capital regulations—deserve attention. The countercyclical capital buffer (CCyB), introduced under Basel III, requires banks to hold more capital during booms to limit excessive credit growth and overheating (BIS, 2010). These buffers are meant to be released in downturns to support credit expansion. Yet during the COVID-19 crisis, many banks did not increase lending despite relaxed buffers, revealing a weak countercyclical response (IMF, 2021; ESRB, 2022).


One solution is to mandate credit expansion by relaxing capital requirements or injecting public equity into banks, allowing them to lend without breaching regulatory ratios. The U.S. Treasury's TARP program during the 2008 crisis successfully stabilized banks and later recovered its investment, earning a return (SIGTARP, 2017). By allowing governments to recapitalize banks in recessions and sell shares during recoveries, leverage-based tools offer sustainable stimulus.


The Drawbacks of Quantitative Easing


QE operates indirectly by lowering long-term interest rates and encouraging investors to seek higher yields. However, much of this liquidity inflates financial asset prices rather than boosting real economy demand (Furceri et al., 2021). Asset price inflation disproportionately benefits wealthier households, amplifying inequality and financial vulnerability. Moreover, QE-induced risk-taking may lead to asset bubbles. During the COVID-19 crisis, the Federal Reserve even purchased high-yield corporate bonds and ETFs to support dysfunctional markets (Federal Reserve, 2020), raising questions about moral hazard and central bank independence.


Advantages of Leverage Tools


Leverage-based policies, in contrast, target consumption directly, especially through household credit expansion. Mandating banks to fund consumer loans—such as via credit cards—ensures liquidity reaches end-users rather than being diverted into speculative investments. These tools also preserve private-sector discipline, as banks continue to bear credit risk, unlike QE which often transfers that risk to the public sector (Cecchetti & Schoenholtz, 2020).


In terms of sustainability, leverage policies allow for natural exit strategies. For example, capital injections into banks can be recouped during recovery via equity sales, as seen in the U.S. post-2008. By contrast, QE often results in persistent balance sheet expansion. The Fed’s balance sheet grew from under $1 trillion in 2007 to over $9 trillion by 2022, with only limited success in shrinking it afterward (Federal Reserve, 2023).


Combining QE and Leverage Tools


A hybrid approach may offer the best of both worlds. QE can provide a liquidity backstop, while leverage tools ensure actual credit expansion. One key benefit of this approach is correcting the QE-induced collapse in the money multiplier. As banks hoard reserves rather than lend, QE fails to stimulate broad money growth. Enforcing credit expansion through macroprudential leverage tools would restore the monetary transmission channel and enhance policy effectiveness (Gambacorta & Shin, 2018).


References


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