Is John Cochrane’s “The Banks Just Swapped Treasuries For Reserves—QE Was Mostly Inert” Narrative A Little Glib? Do Right-Wingers Confuse Financial Intermediaries With Ultimate Bond Buyers And Sellers?

A Benjamin Cole post

Many right-wingers predicted the Hyper-Inflationary Doomsday when the U.S. Federal Reserve undertook quantitative easing back in 2009. The Fed ultimately bought about $4 trillion in Treasuries and mortgage-backed securities, and we now see near-deflation on the horizon.

Meanwhile, economic growth in the U.S. picked up after QE, particularly when the Fed finally went to open-ended results-dependent QE3 in 2012. It sure looks like central bank QE and printing (digitizing) money works, at least when you have an underutilized modern-day economy near deflation (duh). My guess is the Fed should have done QE bigger, harder and longer.

Never to be chastened, the right-wing had to develop a new counter-argument to this heresy of a central bank printing money with good results. But the standard-issue right-wing hyperinflation-scare stories were in tatters.

Thus, the “banks just swapped Treasuries for reserves” argument was fashioned, with a side-dollop story that QE was mostly inert. The “economy recovered through natural forces, and see the 1921 recession” story line emerged.

Some right-wingers even say, “The Fed did not print money.”


But let’s examine the “with Fed QE, banks just swapped Treasuries-for-reserves” narrative. Does it hold water?

Well, no.

The Federal Reserve did buy $3 trillion in Treasuries—but not from commercial banks. The Fed buys their Treasuries from “primary dealers.” That is a list of 21 firms that includes Cantor Fitzgerald, Goldman Sachs, Jefferies, Nomura Securities, etc. These are government bond-dealers. Not commercial banks. Even with Glass-Steagall in ruin, these old business lines broadly hold up.

The primary dealers did not have $3 trillion in Treasuries in their own accounts or inventories, so they had to go into bond markets and buy $3 trillion in Treasuries, and sell those to the Fed.

The Fed, in fact, printed (digitized) $3 trillion and bought the Treasuries from the primary dealers. The primary dealers bought the Treasuries from the real sellers, who were people and companies. The primary dealers were intermediaries.

So where swelling commercial bank reserves come from? From the NY Fed: “So when the Fed sends and receives funds from the [primary] dealer’s account at its clearing bank [depositary institution, or commercial bank], this action adds or drains reserves to the banking system.”


Now, after QE, the real or ultimate sellers of the Treasuries —not the primary dealers—had the freshly printed (digitized) Fed cash in their hands.

The real, or ultimate, private-sector bond sellers could then buy other bonds, or equities, or property, or spend the money, or bank it.

Now, it happens at the time the Fed was conducting QE that commercial bank deposits in the U.S. also swelled.

To be sure, some of the people and companies selling Treasuries to the primary dealers simply banked the freshly printed money, causing commercial bank deposits and related reserves to swell. And such deposits could be said to be “inert.”

But the swelling in bank deposits had many fathers. Households were also paying down debts and saving more in bank accounts. Corporations were and are sitting on growing cash hoards. Then, there is an undetermined amount of global flight capital deposited and parked into U.S. banks, from the Mideast and Far East.

In short, the people selling Treasuries to the primary dealers put some of the freshly printed money into banks, but they also then bought equities or property or bonds or spent the loot. All good, all expected—and all stimulative to the economy. And as the economy had plenty of slack, stimulative but not inflationary.

John Cochrane

John Cochrane, the brilliant University of Chicago econ prof, has long touted the desirability of commercial banks with trillions of dollars of excess reserves, and he may have a point.

But Cochrane also reprises that “banks just swapped Treasuries for reserves” theme. But he never explains where primary dealers obtained the bonds they sold to the Fed, or that primary dealers have accounts at depositary institutions.

It strikes me that Cochrane is providing a glib explanation, and obscures some very important facts on the ground: Like who are the ultimate sellers of the bonds purchased by the Fed, and what do they really do with the freshly printed cash they have in their pockets?

5 thoughts on “Is John Cochrane’s “The Banks Just Swapped Treasuries For Reserves—QE Was Mostly Inert” Narrative A Little Glib? Do Right-Wingers Confuse Financial Intermediaries With Ultimate Bond Buyers And Sellers?

  1. Thanks Marcus, I think this is all exactly right.

    When we have a $750B output gap in a $18T economy, we only need to bump real spending up by 4% to absorb it. How much QE is required? No one really knows, but to assume that $3T in QE has no effect, even at the margin, seems completely absurd. Yes, a lot of the dollars wound up in reserves, but on their way there, it is very possible they got spent (new money buys a bond, bond seller buys an iPhone, Apple keeps the cash in the bank.) That happens enough times, the output gap goes away. In other words, I agree exactly, hidden in the phrase “swapped bonds for reserves” is the possibility that the money got spent, maybe several times, on that path.

    Speaking of Cochrane, his article is really bothering me because he asserts that the real value of government debt is determined by market expectation of future government surpluses, and because the nominal value of the debt is known/fixed, the price level is therefore determined by expectation of surpluses. This just seems so crazy to me I don’t know where to start. I don’t care about his micro-founded model; I just can’t believe for a minute that people are all sitting around thinking about the time-path of distant-future US government surpluses to decide how to price today’s products/services. What am I missing?


    Kenneth Duda
    Menlo Park, CA

    • Ken–
      The fresh cash in the hands of the real bond sellers–those who sell their bonds to the primary dealers, who in turn sell the bonds to the Federal Reserve—does not contribute to reserves. The real bond sellers can bank their money, building bank deposits. I should
      have perhaps added yet another chart to the blog, and that shows bank deposits growing nicely through the recession but not bulging. This suggests that the QE money was invested or spent and not merely deposited in banks.

      contribute to an increase in bank deposits.

  2. Benjamin, you were doing so well.
    The newly created money ends up in banks not matter how circuitous the route. Newly created money cannot be destroyed except by the reverse of the way it was created. Commercial bank loans being retired. The FRB selling bonds to the primary dealers.

    Money invested or spent goes into someone’s bank account. In the aggregate the money, except for currency float, is in someone’s bank account. And money in someone’s bank account is called reserves as the banks bank accounts are called such.

    The reason you don’t see a bulge in the money supply is that deleveraging occurred elsewhere. Mainly in the financial industry, which offset the newly created money that ended up in banks bank accounts called reserves.

  3. “The primary dealers did not have $3 trillion in Treasuries in their own accounts or inventories, so they had to go into bond markets and buy $3 trillion in Treasuries, and sell those to the Fed.”

    The primary dealers may have mostly gone to the commercial banks directly and avoided the open market to obtain bonds to sell to the FRB. This way the PDs most certainly got their bonds on credit. The commercial banks then replaced bonds they sold to the PDs. This is how I think you follow the new money into the economy. The banks using the proceeds to buy more bonds from the PDs after the PDs buy them at Treasury auctions.

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