Posts Tagged ‘jon hilsenrath’

The Fed does not print money

23 December 2010

The Fed creates reserves, not money.  I’ve covered this one before.  Fed Chair Ben Bernanke has been making the same distinction lately, though it seems he’s muddied it in the past.

Once again:  The Fed creates reserves, not money.  The Fed buys securities from banks and pays for them by giving the banks reserves, e.g., if it buys a $1000 Treasury bond from a bank, it pays the bank by adding $1000 to the bank’s reserve account  at the Fed.  This is not the same thing as giving the banks money, because it ain’t money unless it’s (1) cash circulating outside of the banking system or (2) in someone’s checking, savings, or other deposit account at a bank or money-market fund.

This distinction might sound nitpicky, but it’s all-important.  The process by which these reserves become money is the process by which monetary policy works, or fails to work.  What’s supposed to happen is this:

Fed creates reserves –> banks loan out reserves to households and businesses –> households and businesses spend those funds (raising the Consumption and Investment parts of GDP, hence raising GDP) –> whoever gets paid by them deposits some of those funds in the banks or in money-market funds, and spends some of it –> whoever gets that money deposits some of it and spends some of it –> etc.  Money does get created, indirectly, when those loans are deposited or redeposited in the banking system, but not before then.

That’s what happens when monetary policy works.  (And yes, there may be some inflation, if the increased demand for consumption and investment goods isn’t met by an increase in their availability.)  But that’s not what’s been happening since 2008 — the Fed has been creating reserves, and banks have mostly been sitting on those reserves.  Thus no big increase in Consumption, Investment, or GDP, and no corresponding increase in the money supply.

When someone says “The Fed prints money,” what they’re really saying is that they don’t know what they’re talking about.

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