Is the Federal Reserve Printing Money?

Does the Nation's Central Bank Actually Print Money?

federal reserve print money
The Federal Reserve doesn't actually print money, but the effect is just the same. Photo: Getty Images

What does it mean when they say the Federal Reserve is printing money? Only the Treasury Department has the authority to print U.S. dollars. But most of the money in use today is not cash. Instead, it's credit that's added to banks' deposits. It's the same kind of credit you receive when your employer deposits your paycheck directly into your bank account. When the Federal Reserve "prints money," it's adding credit to its member banks' deposits.


In this way, the Federal Reserve manages the amount of capital that is available to spend or invest. The total amount of capital is known as the money supply. The availability of that money supply is called liquidity. The Fed manages liquidity with monetary policy. The tools it uses most often are open market operations and the fed funds rate

How Exactly Does the Fed "Print Money"?

People say the Fed is printing money whenever it engages in expansive monetary policy. By lowering the fed funds rate target, the Fed lowers all bank rates. It adds liquidity, and has the same effect as printing money. 

High liquidity occurs when interest rates are low. That makes capital affordable, so businesses and investors are more likely to borrow. The return on investment only has to be higher than the interest rate, so more investments look good. In this way, high liquidity spurs economic growth.

The Fed also adds to the money supply when it engages in open market operations.

 It buys Treasuries from its member banks. It pays them by adding the same amount to their credit on their books. But as far as the economy is concerned, it has the same effect as printing $100 bills and handing them out in Times Square. Quantitative easing was a massive expansion of open market operations.

With it, the Fed created $4 trillion in credit between December 2008 and October 2014.

If overdone, credit expansion creates inflation. As cheap capital chases fewer and fewer solid ventures, then the prices of those assets increase. That's true whether the ventures are in houses, gold, barrels of oil or high-tech companies. All of those categories experienced inflation in the last decade.

The most commonly-used measure of inflation, the Consumer Price Index, doesn't record these price increases. It captures oil prices, but not gold or stock prices. It measures housing, but it uses a statistic that measures rental prices, not houses for sale. That's why the Fed's actions can easily create asset bubbles instead of inflation. Here are examples of recent asset bubbles.

Asset bubbles lead to "irrational exuberance." Eventually, more of this capital is invested in risky ventures. As they go defunct, investors panic. Prices plummet as they scramble madly to sell. That's what happened with mortgage-backed securities during the 2007 Banking Liquidity Crisis. This phase of the business cycle, known as contraction, usually leads to a recession. The Fed then "prints money" to spur borrowing, investing and economic growth.

Can the Fed "Unprint" Money?

People get concerned about the Federal Reserve printing money because they don't understand how the Fed can "unprint" money. It uses contractionary monetary policy to dry up liquidity. It has the same effect as taking money out of circulation.

To reduce the amount of capital in the money supply, the Fed raises the fed funds rate. When that happens, banks have less money to lend. They've got to pay each other more to keep fed funds in the overnight account to fulfill the Fed's reserve requirement.

Raising the Fed funds rate also increases all other interest rates. That makes it more expensive to borrow for business expansion, automobiles and homes. That slows economic growth, drying up the demand needed to drive inflation.

The Fed will reverse the effects of QE after the fed funds rate has stabilized at 2 percent.

That may happen in 2018. The Fed will sell Treasurys and mortgage-backed securities to its banks. People worry that the banks won't buy these securities, but they don't have a choice. The Fed simply removes credit from the banks' balance sheets and replaces them with these securities.

What happens to the credit? It vanishes. In other words, it returns to the thin air where the Fed got it in the first place.That's how the Fed "unprints dollars" just as easily as it "printed" them.