Reply To: Fed isn't "really" printing money?


When a commercial bank sell Treasury securities to the Fed, its total assets are initially unchanged. However, the Fed permits commercial banks to hold less than 10 percent of the total checking account balances of their customers as reserves. With additional reserves, therefore, commercial banks are able to generate more than 10 times the additional reserves in checking accounts of their customers. They increase the checking account balances of their customers by extending them loans. So. the total assets of commercial banks increase (as do their liabilities) and the additional loans stimulate spending and production.

For example, Bank A sells $1 million in Treasury securities to the Fed and the Fed pays with $1 million in reserves. With $1 million more in reserves, Bank A can have $10 million more in checking account balances of its customers and still meet the Fed’s reserve requirement ratio of 10 percent. The bank then extends loans of $10 million to its customers and writes the loan proceeds into their checking accounts. The increase supply of credit pushes interest rates down. The lower interest rates and the spending of the newly-created money by the borrowers, pushes up prices of goods they are buying. Entrepreneur who are producing these goods expand production which increases the demand for inputs they are buying. The prices of the input they are using and the prices of the assets they are using both increase. The boom is underway.

Take a look at Murray Rothbard’s book, What Has Government Done to Our Money.

The reasons that QE3 is not producing this chain of effects are first, in a depression, when banks sell assets to the Fed the hold the reserves and do not create credit. Excess reserves, which are typically between 5 and 10 percent of checking account balances are currently well over 100 percent. And second, in a period of unpredictable policy measures, investors hold cash instead of investing in production.

Take a look at Robert Higgs’s article, “Regime Uncertainty: Why the Great Depression Lasted So Long and Why Prosperity Resumed after the War.”