personal views of a former fed trader

Quantitative Easing Step-by-Step

This post describes the nitty gritty of what happens when the Fed purchases Treasuries. I will go into detail on the balance sheet implications for each participant, which will vary depending on whether the market participant is a bank or a non-bank. The bank/non-bank distinction matters because non-banks do not have Fed accounts and thus cannot hold reserves.

The Fed only does QE trades through Primary Dealers, who generally are not banks (they are broker-dealers) and do not have Fed accounts. (The exception is few U.S. branches of foreign banks who house their broker-dealer business in the bank entity, which do have reserve accounts). In practice, Primary Dealers tend to bank with custodian banks like Bank of New York Mellon, who specialize in collateral management services.

But the focus should not be the primary dealers as they are merely conduits. The newly created reserves ultimately end up in the account of whoever sold the Primary Dealer the Treasuries. If the seller is a Bank, then it will end up in the Bank’s Fed account. If the seller is a non-bank, it will end up in the Fed account of the bank that the Non-Bank banks with. The bank’s new reserve asset will be balanced against new bank deposit liabilities owed to the Non-Bank.

Below I walk through four scenarios of QE sales: Non-Bank Investor to Non-Bank Primary Dealer, Bank Investors to Bank Primary Dealer, Bank Investor to Non-Bank Primary Dealer, and Non-Bank Investor to Bank Primary Dealer. This should offer insight into the plumbing of QE.

Non-Bank Sells Treasuries to Non-Bank Primary Dealers

In this common scenario the non-bank Primary Dealer buys Treasuries from a Non-Bank (could be a corporation, hedge fund, mutual fund, another dealer etc.). The Primary Dealer borrows money from a money market fund via the repo market to make the purchase. The Treasury purchased is immediately pledged as collateral for the money market fund’s repo loan. The Primary Dealer will repay the repo loan using the proceeds it receives from selling the Treasury to the Fed.

Note that none of these entities have reserve accounts. The QE reserve impact happens behind the scenes when the commercial banks that the participants have accounts with settle payments with each other. Recall, reserves are basically a special type of money used for transactions between commercial banks.  Reserves will move from the money market fund’s bank to the Non-Bank’s Bank, via the Primary Dealer’s Bank.

The Primary Dealer then sells the Treasury to the Fed, and repays the repo loan to the money market fund.

At the end of the day, there are $100 more reserves in the banking system. They end up in the Fed account of the non-Bank’s bank. The Non-Bank itself essentially exchanges Treasuries for bank deposits.

Bank Sells Treasuries to Bank Primary Dealers

In this scenario a Bank sells Treasuries to a Primary Dealer who is also a Bank, who then sells it to the Fed. Because all entities have Fed accounts, all transactions are settled in reserves. (The Primary Dealer can also fund the transaction using a repo loan, but for simplicity I construct the example assuming it has enough reserves to not need funding.)

Bank Sells to Non-Bank Primary Dealer

In this scenario things are bit more complicated because one participant has a reserve account, while others do not. At the end of the day the Fed increases its balance sheet, and the Bank Seller swaps Treasuries for reserves.

The Primary Dealer intermediates this by buying the Treasuries with funding from a repo loan and then sells the Treasuries to the Fed. Behind the scenes, the Primary Dealer’s Bank receives reserves from the Money Market Fund’s Bank, then sends them to the Bank Seller. Then the Primary Dealer’s bank receives reserves from the Fed when the Primary Dealer sells the Treasuries to the Fed. And finally, the Primary Dealer’s bank sends reserves to the Money Market Fund’s bank when the Primary Dealer repays the repo loan.  Note all these transactions take place within a day.

Non-Bank Sells to Bank Primary Dealer

In this example a Non-Bank sells Treasuries to a Primary Dealer who is also a bank. The Non-Bank cannot hold reserves, so the Treasuries are sold for bank deposits, which are created by the Non-Bank’s bank. The Non-Bank’s bank holds the reserves, while increasing its bank deposit liabilities to the Non-Bank. The Bank Primary Dealer funds the purchase with a repo loan from a money market fund.


  1. James

    Thank you for the information. I now understand why people just call QE ‘money printing’ because its easier.

  2. bm

    If it’s money printing, why we haven’t seen hyper-inflation yet, after almost doubling FED’s balance sheet? Why Japan, after decades of QE, is struggling with deflation? (Honest questions – I’m trying to understand this).

    • Fed Guy

      QE is more about changing the composition of money – fewer Treasuries, more bank deposits – than the quantity. The impact of that is lower interest rates, which pushes investors into riskier assets (the ‘portfolio rebalancing’ effect). Thus QE pushes asset prices higher, rather than the prices of goods and services, which is what indexes like CPI measure.

      • bm

        Many thanks for clarifying this.

      • Marko

        Excellent article. Exactly its a duration swap. It hasnt provided any overall lending growth. If that cash isnt being spent by the recipient into the real economy why expect inflation? The fed isnt forcing the secondary market to sell treasuries or preventing the secondary from purchasing them. Its just supporting the market for securities that are likely unproductive assets… ie gov debt.

  3. James

    Hello Fed Guy,

    Hope you are well. Very much enjoying your content.

    I hope you pick this question up. I’m trying to learn about this, so bear with me on what I hope is a sensible question.

    When the Fed creates new reserves to pay for the bond already held by an asset manager, would I be right in saying that that bond is being bought and paid for again a second time? New money in the form of reserves is being created to pay for the same asset again that the original bond investor has already lent the bond issuer the money for.

    Forgive me if my explanation isn’t completely clear.

    • Fed Guy

      When an asset manager buys a bond, he is using money already existing in the system. But when the Fed buys a bond, the Fed is purchasing with newly created money. I’ll walk through this to be more concrete.

      1)I buy a $100 bond issued by a corporation (lending them money). At the end of the day the corporation has $100 more money, and I have $100 less (I have a bond instead). So the total money in the system is not changed.
      2)I sell $100 bond to Fed. To purchase the bond, the Fed creates money out of thin air. At the end of the day then there is $100 more money in the system (technically, it is $100 more reserves balance by $100 more in bank deposits. non-banks don’t have reserve accounts and must transact through the banking system with trading with the Fed see – two tiered monetary system).

      • James

        Thank you for the clear explanation, I understand.

        So, the bond is actually being purchased twice, with newly created money in the form of reserves to pay for the second purchase by the Fed when they purchase the bond from the asset manager. It’s feels like the asset manager is getting free money on the second purchase of the bond by the Fed when the new reserves are created. As you say, there’s $100 more money in the system. Who does that actually belong to ?

        I’ve read all of your blog posts which are excellent to say the least. Sincere thanks for taking the time to explain such an arcane subject to the non-practitioners out there.

        • Fed Guy

          Thanks for your support. The asset manager doesn’t get free money because he must give up the bond – it’s an exchange. The Fed gains the bond, but now owes someone $100. Another way to think about this is that the composition of assets held by the private sector changes. Now instead of holding a $100 bond, it holds $100. In practice the Fed is buying Treasuries, which are credit risk free assets. So the composition of safe assets changes, rather than the quantity.

          • James

            Thank you again for taking the time to reply.

            Okay, I understand that’s perfectly clear.

            Just one more question though if I may please. The original proceeds that were invested in the bond the first time, would I be correct in saying that they are returned to the bond holder, which in this case, is the asset manager such as a pension fund or sovereign wealth fund etc? That would then straighten out the composition of the assets on the balance sheet.

            My apologies for the continual questions. I’m going to read your posts thoroughly again.

            Thanks again for your time. Have a great weekend.

          • Fed Guy

            In a simplified example you can think of it that way. In practice an institutional investor will be talking with securities dealers to sell and buy throughout the day. The central bank’s activity is just another market participant among an ocean of others.
            For example – Investor A thought the bond was a good deal, so he purchased the bond. But then he changed his mind so he called up his dealer, who bought it from Investor A and re-sold it to Investor B. Investor B held on to it for a month, but wanted some cash to buy a new house. So Investor B called up his dealer, who bought it from Investor B and then sold it to the central bank.

  4. James

    Thank you for the explanation and for taking the time.

    Very much appreciate all of your help and insight.

  5. Anonymous

    You’re saying Primary Dealers are just conduits? They interact with the Fed via OMO. The Fed is not purchasing directly from investors. PD’s purchase T’s at auction, warehouse the T’s, and sell them off to the public over time. No Fed needed here. This idea that the Fed creates new bank deposits with commercial by purchasing T’s from investors seems to be inaccurate. This comes from the paper on money creation by the BoE, which I read. I found that paper to have a lot of holes, so did Jeff Snider.

    • Fed Guy

      Fed pays for its QE purchases using reserves it creates. This increases the level of reserve assets held by banks, which must be balanced by a liability. That is usually a bank deposit. To be concrete – an investor sells a Treasury to the Fed and receives bank deposits in its account. The investor’s bank receives reserves. So at the end of the day the banking sector has more reserve assets and deposit liabilities. For more details see this post.

  6. L. J.


    Not sure where to post this question (I’m new to your website)… Please excuse me if this is not the correct place to post it.

    I am an accountant, and I work for a small (<$2 billion) community bank on the East Coast in their accounting department. When we generate a loan, we actually wire out cash to another bank. But, from what I have read, Money Center Banks don't wire out the cash, they just create an offsetting deposit when they originate a loan. Is my understanding correct regarding Money Center Banks creating deposits and not wiring out cash when generating a loan?

    I am really enjoying your website. This is great information.

    • Fed Guy

      Loans create off-setting deposits, but if those deposits are then sent to someone who banks at another bank then cash will be wired out. One of a bank’s primary job is to manage that liquidity risk. Many people have accounts at money center banks, so when a money center bank create an off-setting deposit it is often used to pay someone who also banks at the money center bank. So it would just be a shuffling of liabilities on the bank’s balance sheet from account A to account B (no need to wire out money). I recommend this brief pamphlet from the Bank of England for more details.

  7. Tumisho

    Do banks, who have reserves with the Fed buy treasuries at auction using excess reserves, meaning that the treasury receives money that was never in the system, which in turn leads to an increase in the money supply?

    • Joseph Wang

      Reserves held by banks are already in the money supply. The money supply increases when the Fed buys Treasuries. The Fed creates reserves to buy them, which increases the reserve assets and bank deposit liabilities in the banking system.

      • Bjorn

        But money supply doesn’t increase all the time when Fed does QE. Japan has been doing QE yet money supply hasn’t increased dramatically. And not all deposits(liabilities of com. bank) are backed by bank reserves. If all reserves were in the money supply, perhaps the Fed’s balance sheet would be equal to M2?

  8. Igor

    I am unsure if I understand some details of the “Non-Bank Sells Treasuries to Non-Bank Primary Dealers” example.
    1. Do the 100 $ MMF shares exist before any transactions occur, and are they constant throughout the example?
    2. Shouldn’t all transactions of the MMF’s Bank cancel out at the end? The 4th figure says it still has 100 Reserves and 100 Deposits, but the Non-Banks’ Bank also has them.

    • Carlo MP

      1. Yes MMF shares exist before the transactions occur – they represent money already in the system. These shares were bought by a MMF investor who purchased the shares of the MMF in exchange for cash (investor’s deposits in the investor’s bank). MMFs are considered to be extremely low risk investments. Emphasis on “considered to be”.

      2. The MMF bank’s reserves and deposits merely reverted to the same amount before the repo transaction – once the repo loan was paid off by the Primary Dealer. The new reserves and deposits were created by the stroke of a keyboard at the Fed and ended up with the non-bank’s bank and bank respectively.

  9. Carlo MP

    In Bank Sells Treasuries to Bank Primary Dealer, it looks like the Bank Primary Dealer does NOT use a repo loan from a Money Market Fund. Is that the actual case? Or is it a matter of swapping reserves entirely, without Money Market Funded loans?

  10. Dave

    “The Primary Dealer borrows money from a money market fund via the repo market to make the purchase. The Treasury purchased is immediately pledged as collateral for the money market fund’s repo loan. The Primary Dealer will repay the repo loan using the proceeds it receives from selling the Treasury to the Fed.”

    I think there is generally a lot of confusion surrounding Primary Dealers and what else they do. For example, how can a PD pledge a security that it hasn’t bought yet with the MMF’s loan? Doesn’t it need to pledge an existing security immediately upon entering the repo agreement? Or is this a result of the delay in settlement period of repo so that the collateral can be delivered later on?

    Would you also be able to explain if the above description is the same thing as a “matched book repo”? Or does matched book refer to re-hypothecating within the same day? It would be helpful to understand how primary dealers run these matched books. Is this the market-making function of PDs, or the provide clients funding part?


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