The Fed turns on printing press: The Implications

The Fed turns on printing press
Sewell Chan, Washington
November 5, 2010

IN ITS latest move to help the economy, the Federal Reserve is about to restart its monetary printing press - or rather, the electronic equivalent.

The Fed announced that it intended to buy $US600 billion in long-term Treasury securities through June. It also signalled that it could make more purchases after that if unemployment remained too high and inflation too low.

The Fed is prohibited under law from directly lending to the Treasury Department, which issues government debt. So the Fed buys government securities on the open market from ''primary dealers'', a network of 18 institutions, including Goldman Sachs and Morgan Stanley, that constantly trade in such securities.

While monetary policy is set at the Fed's headquarters in Washington, it is carried out in Lower Manhattan, at the Federal Reserve Bank of New York, which buys and sells Treasury securities and other assets on the Fed's behalf.

In typical recessions, when the Fed pumps money into the economy, it buys assets, like government bonds, and creates an equivalent amount in liabilities - reserve deposits that commercial banks keep at the Fed. Those deposits, which now exceed $US1 trillion, along with currency in circulation, now $US961.4 billion, make up what economists call the monetary base - in essence, the raw material from which money is created and made available to consumers and businesses.

If banks were quickly start quickly using the reserves to make loans, the supply of money, now $US8.7 trillion by one estimate, could grow rapidly and lead to inflation even as the amount of reserves remained constant.

The supply of money includes not just currency, but also things like bank deposits, savings accounts and money market funds.

For now, that seems highly unlikely. Banks say there is not much demand for loans.

NEW YORK TIMES