Friday, December 26, 2008

Will quantitative easing lead to more bank lending?

Aggressive monetary policy, such as quantitative easing, were meant to make banks lend. The Fed is supposed to put so much currency into the system that holding onto cash becomes uneconomic.

But banks do not merely look at yields when deciding whether to lend. They look at a borrower’s credit.

This unraveling recession is changing a lot of business assumptions, many made only a few months ago. What just a few months ago seemed to feasible now no longer are. What just a few months ago are financeable now no longer are.

As long as businesses stand to lose more customers, as more customers stand to lose jobs, and as more goods stand to go unsold, borrowers’ credit are going to deteriorate.

Banks will not lend if businesses are no longer feasible. The solution to the lack of bank lending has to be increasing aggregate demand. Quantitative easing may only debase the currency, which will make financing fiscal deficits more difficult.

Similar-themed post here.

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