[Jthomp76]

I was listening to Peter Schiff Friday and a caller asked a question to which Peter gave a weak answer. He seemed confused by the question in fact. The caller said he noticed that the fed’s balance sheet the last month or so, under the notes category on the liability side, only grew by something like $4 billion. He surmised that they were mostly using reserves from member banks to make their $85 billion in purchases per month and not expanding their balance sheet by printing money. Peter just said they have to print to make these purchases and didn’t really address the question. Was the caller correct?

[jmherbener]

To buy securities, the Fed must either sell other assets or incur liabilities. It has several asset categories it could use and a few liability categories. So, it can buy securities without expanding base money.

For the week Dec. 4-11, Federal Reserve Banks increased their Securities $58,443 million, The Federal Reserve Bank incurred liabilities of $26,149 in Reverse Repurchase Agreements and $29,095 in Deposits. Deposits Held by Depository Institutions (i.e., Commercial Bank Reserves) increased by $30,096.

http://www.federalreserve.gov/releases/h41/current/h41.htm (Table 8)

So the Fed’s purchase of securities of $58 billion was roughly neutral to base money. It expanded bank reserves by $30 billion and contracted them by $26 billion. In its reverse repos, the Fed sells securities to counter parties with an agreement to buy them back.

http://www.federalreserve.gov/monetarypolicy/bst_frliabilities.htm

[Jthomp76]

So the fed is not printing $85 billion per month as we keep hearing?

[jmherbener]

The $58 billion is for the week of Dec. 4-11. We will have to wait and see if the monthly total comes to $85 billion. (I inadvertently wrote “million” in my post, which is now corrected.)

[Jthomp76]

My main question is does the fed necessarily print or create the money out of thin air each time it purchases these treasuries and MBSs? All we read in Austrian circles is that this is the case. Are you saying sometimes they do not simply create the money to make these purchases? Rather they use reserves they acquire through the sale of assets or reverse repos?

[jmherbener]

Yes, just like anybody else, the Fed can finance its purchase of something by selling an asset it already owns and using the funds to buy what it wants or it can incur a liability to pay for what it buys.

When the Fed literally prints money or when it credits deposits that banks hold at the Fed it is incurring liabilities for itself. But the Fed can also fund its purchases by selling assets.

As I pointed out in a post above, the Fed bought $58 billion in securities in the week of Dec. 4 and created only $4 billion in new bank reserves.

So, the answer to your question is no the Fed does not necessarily print money or create bank reserves each time it purchases treasuries.

[Jthomp76]

Wow, so Schiff and a lot of other libertarian economists are wrong. Maybe this is partially why inflation isn’t as bad as predicted by many?

[jmherbener]

One has to look at the evidence to see whether or not bank reserves expand when the Fed buys securities. Often they do, sometimes they don’t.

But in our current situation, in which banks are holding over $2 trillion in excess reserves, muted price inflation has little to do with the Fed using reverse repos to counter-balance a further increase in reserves from its securities purchases. Price inflation has been muted for two reasons. First, because banks have been building excess reserves instead of creating fiduciary media. And, second because the demand to hold money has been increasing.

[Jthomp76]

Can you explain why banks aren’t making loans?

[jmherbener]

When the crisis came, banks were illiquid and insolvent. The QEs were designed to provide them both liquidity and solvency. They are not lending because demand for credit has dried up and they want to remain liquid until demand returns.

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