Quantitative easing is not just about increasing bank reserves or lowering interest rates.

When the Fed purchases (perhaps indirectly via its so-called primary dealers) long term government bonds from banks, firms, and households, banks receive additional reserves, and firms and households receive additional cash balances. Since the demand for credit is low and creditworthy borrowers few, banks are unlikely to use these additional reserves to finance many new loans — especially while the Fed is paying interest on excess reserves. But what will households and firms do with additional cash balances? If they simply hold the money in place of bonds, then quantitative easing will have utterly failed, but that is precisely why the Fed is purchasing longer term bonds.

Short term bonds with near zero interest rates are extremely close substitutes for money, and so purchasing short term bonds may increase the money supply, but it is also likely to increase money demand in proportion, and so any excess demand for money will remain unchanged. However, purchasing longer term bonds with higher interests rates exchanges quite different assets. Households and firms that sell long term bonds are unlikely to hold their new money, but instead they will begin spending it on various consumer and capital goods. (Initially, they will likely be reluctant to lend for the same reasons as banks).

The increase in spending by households and firms will increase nominal incomes, reduce the real burden of debt, and increase the demand for credit. Banks will then discover more credit-worthy and willing borrowers and start lending more again. Commentators who just talk about increasing the quantity of bank reserves and credit misunderstand the situation. Higher levels of spending will not be caused by bank lending, but rather bank lending will be the effect of higher levels of spending. When this occurs, the Fed will need to begin contracting (or sterilising) a large part of the monetary base to prevent nominal income (and inflation) from rising too quickly. Moreover, interest rates will probably begin rising as inflation expectations rise, the monetary base dries up, and the demand for credit increases.

Whether all this is good for the economy depends on particular pre-conditions holding. If the unusually high level of unemployment is mostly natural, a result of mis-allocated resources during the boom, then quantitative easing is likely to cause little sustainable economic growth and a lot of inflation. However, if most of the increase in unemployment is due to monetary disequilibria, specifically an excess demand for money, then quantitative easing is likely to cause sustainable economic growth and little inflation. Personally, I think the latter conditions hold, and support quantitative easing, even though it is still quite far from my ideal policy.