How the Federal Reserve increases liquidity

September 30, 2007 at 1:34 pm | Posted in economics | Leave a comment

Money creation and the Federal ReserveThere seem to be some misconceptions about the monetary consequences of actions that the Federal Reserve has taken to address liquidity needs.One hears a fair bit of chatter these days along the lines of

The Federal Reserve (and other banking institutions around the world) have poured a couple hundred billion dollars into the system in an attempt to ensure that there is enough “liquidity” for banks to make loans

and references to

the Fed printing money and increasing the money supply on a high scale as if it was dropping money from an helicopter, thus the nickname of Fed Chairman Ben “Helicopter” Bernanke.

I hope in this post to get beyond these sound bites, beginning if I may with some details of the process whereby money is created in the United States. Where did the cash in your wallet come from? Presumably you got it from your bank or ATM. And the reason that the bank was willing to give you that cash was that you already had deposits in an account with the bank, which were in effect credits to obtain cash when you wanted it.

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