Quantitative Easing Policy and the Financial Crisis
Background:
According to standard monetary theory, Quantitative Easing policy implemented after the financial crisis did not entail a credit explosion because the money multiplier has plummeted, as banks have decided to hold excess reserves. Yet, mainstream theory warns that the collapse of the multiplier is ‘temporary’ because in case banks decide to lend reserves massively there may be a burst of inflation.
On the other hand, critics of conventional wisdom hold that Quantitative Easing did not lead to a credit explosion and inflation burst because i) the money multiplier does not have any meaningful sense; and because ii) “the loan is not created out of reserves. And the loan is not created out of deposits: Loans create deposits, not the other way around” (Sheard, 2013).
Question:
Critically evaluate both approaches sketched above.
IMPORTANT:
(You are asked to develop clearly well-articulated, consistent arguments to examine both approaches, by grounding them in readings and showing HOW BALANCE SHEETS ARE AFFECTED WHENEVER POSSIBLE.)
Use some of the references provided below in the essay:
1) Bank of England “How Money is created” Retrieved (Jan. 25, 2021):
2) G. Mankiw (2008) Macroeconomics, chapter: 4.
3) F. Mishkin et al (2013) The Economics of Money, Banking and Financial Markets, chapters: 10, 14, 15.
4) P. Sheard (2013) “Repeat After Me: Banks Cannot And Do Not ‘Lend Out’ Reserves.” Standard and Poors Economic Research paper, 2013.
5) E. Tymoigne (2014) “ Modern Money Theory and Interrelations between the Treasury and the Central Bank: The Case of the United States”. Levy Institute Working Paper No. 788.
6) L. Randall Wray (2012) “Introduction to an Alternative History of Money”. Levy Institute Working Paper No. 717.
