<blockquote>
<p>During QE what prevents the banks from selling government debt to invest in the stock market instead of lending out the money?</p>
</blockquote>
<p>Nothing. Depending on which country we are talking about there might be a regulation preventing/limiting some banks investing in a stock market, in order to make banking sector less prone to collapse. For example, Basel rules mandate that banks have to keep certain level of capital buffer for their investments in stock market in order to make them resilient (see discussion about that <a href="https://www.bis.org/publ/bcbs266.pdf" rel="nofollow noreferrer">here</a>). This is very context dependent, there is actually no such thing as just a bank, there are commercial banks, investment banks, retail banks etc - all are regulated slightly differently and it is beyond scope of an SE answer to provide detailed overview rules for all individual institutions.</p>
<p>Besides that the only thing that would restrict them from doing so is that at some point it would not be profitable, especially if there is sufficient demand for loans.  Both equity and credit prices are subject to supply and demand forces.</p>
<blockquote>
<p>But what if the banks instead of lending out money put most of their money in the stock market?</p>
</blockquote>
<p>Ceteris paribus, this will stimulate economic activity the same way as issuing a loan would. From a macro perspective there is a little difference between bank buying from a firm A a bond with face value 1000USD with 10% coupon rate, versus bank buying 1000USD worth of stock expected to pay 100$ yearly dividend. What stimulates economic activity is firms getting the money (no matter whether as a loan or in exchange for equity) which allows them to increase investment.</p>
<p>If anything buying equity could potentially stimulate economy more, since there is some evidence that debt overhangs make firms invest less (e.g. see this <a href="https://www.clevelandfed.org/en/newsroom-and-events/publications/economic-commentary/economic-commentary-archives/2010-economic-commentaries/ec-201007-is-debt-overhang-causing-firms-to-underinvest.aspx#:%7E:text=A%20debt%2Doverhang%20problem%20arises,short%20of%20its%20face%20value." rel="nofollow noreferrer">Fed St. Louis explainer</a>). Consequently, in situation where firms are already overleveraged such action would likely stimulate economic activity even more than just increase in borrowing.</p>

CC BY-SA 4.0
2021-04-30T06:52:06.207Z
Sorry but I do not understand how firms get the money if the banks buy stocks. Say the banks buys Apple stocks. Now the the Apple stock price rises. Let us say that it doubles. This does not mean that Apple has twice the money to invest in its business.
Andy
CC BY-SA 4.0
2021-04-30T07:31:54.803Z
@Andy companies issue stocks in order to raise capital for investment. If Apple issues 1000USD stock and banks buys it then that 1000USD can be used for investment the same way as a loan can. Most corporations get their money for investment by selling stocks
1muflon1
CC BY-SA 4.0
2021-04-30T07:46:32.700Z
Thank you. I did not know that. But what if the company is already full of cash, like Apple is? In fact Apple has been buying back large amount of stocks not issuing new ones. Then the money may not trickle down into the real economy?
Andy
CC BY-SA 4.0
2021-04-30T08:43:17.470Z
@Andy 1. First of all in economics there is no such thing as ‘trickling down’ that’s pejorative used by politicians. 2. No economy is endogenous system all this will have an effect. If Apple refuses to issue new shares and so banks (or Apple itself) decide to buy existing ones they have to purchase from shareholders. So money ends up with them, then they can only either consume it or save it. If they consume it the consumption stimulates economic activity if they save it then it gets recycled through financial system into new loans or equity purchases that again either stimulate investment
1muflon1
CC BY-SA 4.0
2021-04-30T08:46:19.420Z
Or consumption in the end. The only way how to stop this is for people to take money they got and burn them so they cannot be used for any spending or burry them in a garden I guess. As long as a money is eventually spent onto consumption or investment it will stimulate the economy.
1muflon1
CC BY-SA 4.0
2021-04-30T08:55:04.493Z
But could not the ones selling the Apple stocks be foreign investment banks? In that case the money would not end up in the US economy? Also following this logic a cash handout to every US citizen of say 5000 USD would be a good idea? Since the money in this case also is either spent or invested this will stimulate the economy.
Andy
CC BY-SA 4.0
2021-04-30T09:13:54.847Z
@Andy 1. Yes that would actually work and be a good idea if central banks would be allowed by law to deal with individuals - that is in literature known as ‘helicopter money’. 2. No, there is no such thing as money leaving economy. If US bank wants to buy shares in Japanese company it has to first go to forex market and sell dollars for Japanese yen. Selling dollars increases their supply and buying yen increases demand for yen. This depreciates USD value on exchange rate which means it’s cheaper to buy goods and services and invest in US which again stimulates US economy
1muflon1
CC BY-SA 4.0
2021-04-30T09:58:55.030Z
What if the US government creates a new centralized digital valuta: eUSD and gives each US citizen a fixed amount of eUSD. The Fed then starts buying eUSD in the market which drives up the value of eUSD. I would think this would be legal and would work?
Alternatively the US government could send each US citizen 5 x 1000 USD 10 year treasury bonds, which the Fed could buy back?
Andy
CC BY-SA 4.0
2021-04-30T10:03:57.937Z
@Andy 1. creating new digital currency does not make sense USD is already quite digitalized and most transactions and most new money are already created electronically not printed. 2. No that would make no sense whatsoever if the goal is to stimulate economy, that would create monetary contraction and make recession worse. 3. Fed can only buy bonds from special preaproved dealers. It would be easier to just make it legal for fed to send money directly to households
1muflon1
CC BY-SA 4.0
2021-04-30T10:12:19.303Z
2. Since the citizens would not sell their bonds? If they did sell the bonds they would get USD they could spend which would grow the economy? I guess the price must go up. Issuing new bonds would tend to lower the price of the bonds. But is this not also a matter of the coupon rate of the new bonds? If the new bonds only yielded 1% returns per year would not the existing bonds that returned 2% per year double in price?
Andy
CC BY-SA 4.0
2021-04-30T14:27:04.847Z
@Andy I am not sure why you now segwayed from digital currencies to bonds. Bond value depends on interest rates as it’s a fixed income security the nominal value of bond and coupons are fixed. If nothing changes issuing more bonds does not lead to lower value of a bond directly. There would be an indirect effect because more demand for funds leads to higher interest rate and bond prices are inversely related to interest rate, but having bond A with FA 1000 and C 1% won’t directly change value of a bond with FA 1000 and C 1%. Bond price is given by $$\sum (C)/(1+r)^t + FA/(1+r)^t$$
1muflon1
CC BY-SA 4.0
2021-04-30T14:30:30.240Z
So if interest rate is 0 for simplicity a FA=1000 bond with coupon 1% issued for 1 time period would have value 1010 USD and if there would be 2% coupon bond it would have value 1020USD and these two values would not change regardless of whether the other bond exists or only one of them exists
1muflon1
CC BY-SA 4.0
2021-04-29T19:07:31.237Z
2021-04-29T21:25:39.057Z
2021-04-29T21:25:39.057Z
1muflon1
<p>This is how QE is supposed to work:</p>
<p><a href="https://i.sstatic.net/Bv4nrm.png" rel="nofollow noreferrer"><img src="https://i.sstatic.net/Bv4nrm.png" alt="enter image description here" /></a></p>
<p>The fed buys government debt from banks.
This lowers the long term interest rates and businesses and consumers borrow more, which is good for the economy.</p>
<p>But what if the banks instead of lending out money put most of their money in the stock market?
They know that somewhat later the money will get to the general population.
And some of the general population make a good living. So good in fact that they save a lot of money in index funds, and in particular when the interes rates are low. The banks already know in advance that this will drive up the stock market.
Since they can buy the stocks before the money has reached the general population they can buy the stocks at a lower price.</p>
<p>As a more detailed example assume the investment bank G. Gecko own 1e6 10 years treasury bonds at USD 1000 per bond.
The bonds have a coupon rate of 10 USD, resulting in a yearly return of 20 USD = 2%. Now the Fed starts buying up 10 year treasury bonds and the price of these rises to 2000 USD. Now the return rate of these bonds are only 1%. This is not enough so G. Gecko sells it bonds. Now it has doubled its money but it need to invest these somewhere. So it buys Apple stocks.
Another bank also sell treasury bonds but use the new money to lend out.
This improves the economy and some of the general population gets more money.
Some of this they use to buy Apple stocks. However this drives up the price of the Apple stock. Let us say it doubles. Now G. Gecko have turned their initial 1e9 USD into 4e9 USD. Apple does not benefit directly from the rise in its stock price? The general population seem to benefit from the money trickling down from the other bank but the big winner here seems to be G. Gecko.</p>

CC BY-SA 4.0
2023-08-01T10:38:08.657Z
when you write 1e9 what does that mean
troy beckett
CC BY-SA 4.0
2023-08-01T11:15:34.573Z
1 billion = 1 000 000 000.
Andy
<monetary-policy><nonexpert><quantitative-easing>
During QE what prevents the banks from selling government debt to invest in the stock market instead of lending out the money?
Andy
# During QE what prevents the banks from selling government debt to invest in the stock market instead of lending out the money?

(Asked by: username_0 on 2021-04-29)

This is how QE is supposed to work:

[![enter image description here](https://i.sstatic.net/Bv4nrm.png)](https://i.sstatic.net/Bv4nrm.png)

The fed buys government debt from banks.
This lowers the long term interest rates and businesses and consumers borrow more, which is good for the economy.

But what if the banks instead of lending out money put most of their money in the stock market?
They know that somewhat later the money will get to the general population.
And some of the general population make a good living. So good in fact that they save a lot of money in index funds, and in particular when the interes rates are low. The banks already know in advance that this will drive up the stock market.
Since they can buy the stocks before the money has reached the general population they can buy the stocks at a lower price.

As a more detailed example assume the investment bank G. Gecko own 1e6 10 years treasury bonds at USD 1000 per bond.
The bonds have a coupon rate of 10 USD, resulting in a yearly return of 20 USD = 2%. Now the Fed starts buying up 10 year treasury bonds and the price of these rises to 2000 USD. Now the return rate of these bonds are only 1%. This is not enough so G. Gecko sells it bonds. Now it has doubled its money but it need to invest these somewhere. So it buys Apple stocks.
Another bank also sell treasury bonds but use the new money to lend out.
This improves the economy and some of the general population gets more money.
Some of this they use to buy Apple stocks. However this drives up the price of the Apple stock. Let us say it doubles. Now G. Gecko have turned their initial 1e9 USD into 4e9 USD. Apple does not benefit directly from the rise in its stock price? The general population seem to benefit from the money trickling down from the other bank but the big winner here seems to be G. Gecko.

**Tags:** monetary-policy, nonexpert, quantitative-easing

> **Comments:**
> **username_1**: when you write 1e9 what does that mean  
> **username_0**: 1 billion = 1 000 000 000.  

---

## 1 answers

### Answer by username_2 on 2021-04-29. Score: 3 | Accepted answer

> During QE what prevents the banks from selling government debt to invest in the stock market instead of lending out the money?

Nothing. Depending on which country we are talking about there might be a regulation preventing/limiting some banks investing in a stock market, in order to make banking sector less prone to collapse. For example, Basel rules mandate that banks have to keep certain level of capital buffer for their investments in stock market in order to make them resilient (see discussion about that [here](https://www.bis.org/publ/bcbs266.pdf)). This is very context dependent, there is actually no such thing as just a bank, there are commercial banks, investment banks, retail banks etc - all are regulated slightly differently and it is beyond scope of an SE answer to provide detailed overview rules for all individual institutions.

Besides that the only thing that would restrict them from doing so is that at some point it would not be profitable, especially if there is sufficient demand for loans. Both equity and credit prices are subject to supply and demand forces.

> But what if the banks instead of lending out money put most of their money in the stock market?

Ceteris paribus, this will stimulate economic activity the same way as issuing a loan would. From a macro perspective there is a little difference between bank buying from a firm A a bond with face value 1000USD with 10% coupon rate, versus bank buying 1000USD worth of stock expected to pay 100$ yearly dividend. What stimulates economic activity is firms getting the money (no matter whether as a loan or in exchange for equity) which allows them to increase investment.

If anything buying equity could potentially stimulate economy more, since there is some evidence that debt overhangs make firms invest less (e.g. see this [Fed St. Louis explainer](https://www.clevelandfed.org/en/newsroom-and-events/publications/economic-commentary/economic-commentary-archives/2010-economic-commentaries/ec-201007-is-debt-overhang-causing-firms-to-underinvest.aspx#:%7E:text=A%20debt%2Doverhang%20problem%20arises,short%20of%20its%20face%20value.)). Consequently, in situation where firms are already overleveraged such action would likely stimulate economic activity even more than just increase in borrowing.

> **Comments:**
> **username_0**: Sorry but I do not understand how firms get the money if the banks buy stocks. Say the banks buys Apple stocks. Now the the Apple stock price rises. Let us say that it doubles. This does not mean that Apple has twice the money to invest in its business.  
> **username_2**: @username_0 companies issue stocks in order to raise capital for investment. If Apple issues 1000USD stock and banks buys it then that 1000USD can be used for investment the same way as a loan can. Most corporations get their money for investment by selling stocks  
> **username_0**: Thank you. I did not know that. But what if the company is already full of cash, like Apple is? In fact Apple has been buying back large amount of stocks not issuing new ones. Then the money may not trickle down into the real economy?  
> **username_2**: @username_0 1. First of all in economics there is no such thing as ‘trickling down’ that’s pejorative used by politicians. 2. No economy is endogenous system all this will have an effect. If Apple refuses to issue new shares and so banks (or Apple itself) decide to buy existing ones they have to purchase from shareholders. So money ends up with them, then they can only either consume it or save it. If they consume it the consumption stimulates economic activity if they save it then it gets recycled through financial system into new loans or equity purchases that again either stimulate investment  
> **username_2**: Or consumption in the end. The only way how to stop this is for people to take money they got and burn them so they cannot be used for any spending or burry them in a garden I guess. As long as a money is eventually spent onto consumption or investment it will stimulate the economy.  
> **username_0**: But could not the ones selling the Apple stocks be foreign investment banks? In that case the money would not end up in the US economy? Also following this logic a cash handout to every US citizen of say 5000 USD would be a good idea? Since the money in this case also is either spent or invested this will stimulate the economy.  
> **username_2**: @username_0 1. Yes that would actually work and be a good idea if central banks would be allowed by law to deal with individuals - that is in literature known as ‘helicopter money’. 2. No, there is no such thing as money leaving economy. If US bank wants to buy shares in Japanese company it has to first go to forex market and sell dollars for Japanese yen. Selling dollars increases their supply and buying yen increases demand for yen. This depreciates USD value on exchange rate which means it’s cheaper to buy goods and services and invest in US which again stimulates US economy  
> **username_0**: What if the US government creates a new centralized digital valuta: eUSD and gives each US citizen a fixed amount of eUSD. The Fed then starts buying eUSD in the market which drives up the value of eUSD. I would think this would be legal and would work? Alternatively the US government could send each US citizen 5 x 1000 USD 10 year treasury bonds, which the Fed could buy back?  
> **username_2**: @username_0 1. creating new digital currency does not make sense USD is already quite digitalized and most transactions and most new money are already created electronically not printed. 2. No that would make no sense whatsoever if the goal is to stimulate economy, that would create monetary contraction and make recession worse. 3. Fed can only buy bonds from special preaproved dealers. It would be easier to just make it legal for fed to send money directly to households  
> **username_0**: 2. Since the citizens would not sell their bonds? If they did sell the bonds they would get USD they could spend which would grow the economy? I guess the price must go up. Issuing new bonds would tend to lower the price of the bonds. But is this not also a matter of the coupon rate of the new bonds? If the new bonds only yielded 1% returns per year would not the existing bonds that returned 2% per year double in price?  
> **username_2**: @username_0 I am not sure why you now segwayed from digital currencies to bonds. Bond value depends on interest rates as it’s a fixed income security the nominal value of bond and coupons are fixed. If nothing changes issuing more bonds does not lead to lower value of a bond directly. There would be an indirect effect because more demand for funds leads to higher interest rate and bond prices are inversely related to interest rate, but having bond A with FA 1000 and C 1% won’t directly change value of a bond with FA 1000 and C 1%. Bond price is given by $$\sum (C)/(1+r)^t + FA/(1+r)^t$$  
> **username_2**: So if interest rate is 0 for simplicity a FA=1000 bond with coupon 1% issued for 1 time period would have value 1010 USD and if there would be 2% coupon bond it would have value 1020USD and these two values would not change regardless of whether the other bond exists or only one of them exists  

---

