5 responses to “How does the Fed increase the money supply?”

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  LucaPacioli1492 February 25th, 2010 at 01:55

  The Fed Open Market Committee can purchase Treasury bonds from banks and other holders releasing cash to be circulated in the money supply. The Fed gets the funds for the purchase merely by writing a check ( actually making an electronic bookkeeping entry ) and thus creates money.

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  ADad February 25th, 2010 at 02:38

  Yes . The money is created out of thin air.

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  Ngan Driggars February 25th, 2010 at 04:53

  Thanks for your informative piece.

  I absolutely need to raise my personal awareness of the finance connected areas.

  I will look forward reading through a lot more of your stuff when I have the time.

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  Charlie Bravo February 25th, 2010 at 03:12

  “…..but the money supply increases consistently from year to year?”

  ..thus increasing inflationary concerns…..

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  James L February 25th, 2010 at 03:48

  The three policy tools of the Fed to influence the money supply are:
  1. changing reserve requirement
  2. changing discount rate
  3. Open market operations

  By changing the reserve requirement, the Fed allows banks to create more loans because they don’t have to keep so much on hand in the vault. When banks issue loans, they literally create money “out of thin air.” I won’t attempt to explain this now, as it can be complicated (at least for me). Here are some links though:
  http://www.prosperityuk.com/prosperity/articles/howbcm.html
  http://ingrimayne.com/econ/Banking/Commodity2.html

  When the reserve requirement ratio (RRR) increases, banks loan less, and the money supply decrease, and vice versa. This is used very rarely because it is so powerful due to the money multiplier effect. I think the last time it was used was in the early 1990s, when the Fed lowered the RRR from 12% to 10% in order to bring economy out of recession.

  The second tool used by the Fed is to change the discount rate, the interest rate at which the Fed lends money to insured depository institutions. When the discount rate increase, banks borrow less, and therefore the money supply decrease, and vice versa. This isn’t as important as it used to be because banks can now borrow more easily from each other or find other funds if they are in financial trouble. Borrowing from the fed is usually a last resort.

  The third and most important tool of the Fed is open market operations. This is the buying and selling of Treasury bills. When the Fed buys securities, it pays out currency for those T-bills, thus increasing money supply. When they sell them, they rein in the money supply. This tool is used almost daily.

  Hoped that helped.