Saturday, March 21, 2009

How Does the FED Do It?

Finally our daily newspapers accurately describe how the Federal Reserve puts $1.7 trillion into the economy:
"Are Tax Payers on the hook?
No, the Fed prints money. Not literally--the Treasury ... makes the nation's paper currency. Instead the Fed creates the money to buy the Treasury bonds and other securities. It then adds those securities to its balance sheet .... "

The Associated Press, LSJ, March 20, has this part right, but could do the public a service if it added that it is the same basic process that adds to the money supply when a commercial bank makes a loan.

"Are there any downsides to this? The main risk is that the flood of new dollars will increase inflation as more dollars chase the same amount of goods."

Here the AP goes wrong--the new dollars will create new output, maintenance of state and local roads, schools, etc. The amount of goods is not fixed.

The FED always faces the difficult task of adjusting the money supply (in normal times via monetary policy) to the capacity of the economy to produce. But, does anyone think we can't produce more if we put the unemployed to work?? Sure, they could make a mistake and maintain the stimulus when we again reach full capacity. But, we are far from that now. The greatest danger is that because of old myths and superstitions, we will not put in enough new money. The danger of deflation is greater than the danger of inflation.

1 comment:

The Arthurian said...

Hi, Allan. I like this post. I like your attention to detail in "it is the same basic process that adds to the money supply when a commercial bank makes a loan." And I like your follow-through in "The amount of goods is not fixed."

RE: attention to detail... Correct me if I'm wrong. Taxpayers are not "on the hook" for the $1.7 trillion. But they are, for the interest on it.

This is not yet clear in my mind, but... When money was gold, or backed by gold, the practical way to "get more" pronto was to borrow it... When money is fiat, the door is opened to simple printing. This eliminates the cost of interest.

Many people would balk at that. But you are I are aware of "the danger of inflation" and may be able to discuss it without fear.

When the time comes, as it did for us recently, that central banks find it necessary to increase the quantity of money by 75 billion pounds here and a trillion dollars there, perhaps the better choice would be to create that money without also creating more debt. In other words, simple printing.

Or... as you have it in yours of 24 March 2010: "borrowing interest-free from the Federal Reserve as I have outline in previous posts."

(Your "fiscal stimulus" label on the recent post brought me to this older one.)