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Wouldn’t it be nice if you could just print money? The U.S. Federal
Reserve can. It has pumped roughly $800 billion of new money into the
financial system over the past seven months, and last week said another
trillion dollars or more could be created in months ahead.
But new money doesn’t roll off a printing press and get loaded in
armored trucks. The Fed purchases securities or other assets from
securities dealers in exchange for electronic credits that amount to
cash and are deposited in banks.
The cash credits — known as bank reserves — have grown from $3
billion last August to $776 billion by mid-March. The Fed made clear
this week that reserves will soar in the months ahead, as the central
bank expands its rescue programs.
Sure, the Fed can literally print money through the Bureau of
Engraving and Printing. The central bank’s name is on the money in your
wallet. But that isn’t how it expands money and credit. Since August,
Federal Reserve notes — also known as dollars — have only increased to
$862 billion from $793 billion.
The key to understanding what the Fed does is understanding the
securities it buys. This week, it said it would purchase as much as
$1.25 trillion of mortgage-backed securities backed by the
government-owned mortgage firms Fannie Mae, Freddie Mac and Ginnie Mae.
It will also buy as much as $200 billion of debt issued by those firms.
And, importantly, it will buy up to $300 billion of long-term debt
issued by the U.S. government itself.
The Fed hopes the purchases will drive down long-term interest rates
and make mortgages cheaper. When it buys securities, in theory, that
should drive up the price and drive down the yield.
Some economists find the Fed’s actions alarming, especially its
purchases of government bonds. The Fed is essentially creating money and
lending it to the Treasury. Economists worry this will bloat budget
deficits.
Right now, though, the Fed’s worry isn’t inflation. With so many
factories standing idle and homes sitting empty, it is hard to raise
prices. And the cash the Fed has been pumping into banks isn’t being
turned into loans.
“It is only if the banking system starts to expand credit that you
get higher spending and inflation,” says Ethan Harris, an economist with
Barclays Capital.
Officials hope the new money gets more credit into the economy and
helps to revive the financial system. If all goes according to plan, Fed
officials will pull the extra money during a recovery, pushing interest
rates higher before inflation gets out of hand. |
