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Is the Federal Reserve Printing Money?



The Federal Reserve doesn't actually print money.

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Definition: What does it mean when they say the Federal Reserve is printing money? It doesn't mean the Fed has a printing press that spouts out dollars. Only the Treasury Department does that. However, most of the money, also known as capital, in use today is not cash. Instead, it's credit -- the same kind of credit you receive when your employer deposits your paycheck directly into your bank account.

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, while the availability is known as liquidity.

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 Federal Reserve manages liquidity with monetary policy and the Fed funds rate. By lowering the Fed funds rate target, the Fed lowers all bank rates. This adds liquidity. This has the same effect as printing money.

People say the Fed is printing money whenever it engages in expansive monetary policy. This can be a precursor to inflation. As cheap capital chases fewer and fewer good ventures -- or houses, or gold, or barrels of oil, or high tech companies -- then the prices of those assets increase. This leads to "irrational exuberance." Eventually, more of this capital is invested in bad ventures. As they go defunct, investors panic, and 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.

People get concerned about the Federal Reserve printing money because they don't understand how the Fed can "unprint" money. However, the Fed can just as easily raise the Fed funds rate as lower it. Using these contractiory measures, the Fed can dry up liquidity. This has the same effect as taking money out of circulation. Article updated June 25, 2013

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