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Federal Reserve: Can We Run Out of Money?

Guest Author: Stephanie Kelton

Federal Reserve Chairman Ben Bernanke gave his fourth lecture at George Washington University yesterday. Buried in the lecture, beginning at about 19:18 in the video (shown below), Bernanke explained where the Fed got the money to “pay for” the assets it purchased as part of its Quantitative Easing (QE) policies.

I remember when the Fed announced the first round of QE. Those who don’t understand Fed operations – think most mainstream economists – went nuts. Many worried that the Fed would be unable to “unwind” its positions (i.e. divest itself of the assets – MBS, Treasuries, etc. – it had purchased) because banks would refuse to swap their nice safe cash for riskier instruments when the economy recovered. Others insisted that QE was “stuffing the market full” of too many dollars and that this, inevitably, would result in hyperinflation.

John Carney just wrote a very nice piece, showing that not only was the Fed able to find buyers for its assets but that markets actually bought them back at a premium. Bernanke addresses the second objection in his remarks below – idle balances don’t chase any goods – but it’s the financing of the asset purchases that I want readers to understand, because this is fundamental to understanding Modern Monetary Theory (MMT).

The Federal Reserve, like any bank, can acquire an asset simply by crediting a bank account. In other words, the bank pays by creating money. As Alan Greenspan explained, the Fed has an unlimited capacity to spend in US dollars. It can pay trillions of dollars with a single keystroke. Here is Chairman Bernanke (Readers can follow is presentation beginning on page 17):

Now, you might ask the question, well, the Fed is going out and buying 2 trillion dollars of securities – how did we pay for that? And the answer is that we paid for those securities by crediting the bank accounts of the people who sold them to us, and those accounts, at the banks, showed up as reserves that the banks would hold with the Fed. So the Fed is a bank for the banks. Banks can hold deposit accounts with the Fed, essentially, and those are called reserve accounts. And so as the purchases of securities occurred, the way we paid for them was basically by increasing the amount of reserves that banks had in their accounts with the Fed.

So you can see this, here, this is the liabilities side of the Fed’s balance sheet. Of course, assets and liabilities (including capital) have to be equal. So the liabilities side had also to rise near 3 trillion dollars, as you can see.

Now, take a look first, as you look at this, take a look first at the light blue line at the bottom. The light blue line at the bottom is currency – Federal Reserve notes in circulation. Sometimes you hear that the Fed is printing money in order to pay for the securities we acquire. And I’ve talked about that in some, you know, in giving some conceptual examples. But as a literal fact, the Fed is not printing money to acquire these securities, and you can see it from the balance sheet here, the light blue line is basically flat. The amount of currency in circulation has not been affected by these activities.

What has been affected is the purple area. Those are reserve balances. Those are that accounts that banks, commercial banks, hold with the Fed, and they are assets of the banking system and they are liabilities of the Fed, and that’s basically how we paid for those securities. And so, the banking system has a large quantity of these reserves, but they are electronic entries at the Fed. They basically just sit there. They’re not in circulation. They’re not part of any broad measure of the money supply. They’re part of what’s called the monetary base, but again, they’re not, they certainly aren’t cash.

Then there are other liabilities including Treasury accounts and a variety of other things that the Fed does – we act as the fiscal agent of the Treasury. But the two main items, you can see, are the notes in circulation and the reserves held by the banks.”

So ask yourself this question: If the Federal Reserve can create trillions of dollars with a single keystroke, and the Fed is the government’s bank, then why does President Obama claim we’ve “run out” of money? Why have Democrats and so-called progressives supported job-killing budget cuts in the name of “shared sacrifice”? Why are we throwing away the equivalent of $9.8 billion in lost output every single day? Why don’t we do something about our $2.2 trillion infrastructure deficit, 25 million underemployed and unemployed Americans, 100 million Americans in or very near poverty, and so on?

The answer is simple. Most of us don’t understand the monetary system. Instead of deciding how the government should wield its power over the dollar, we live in fear of the ratings agencies, the Chinese, the bond market vigilantes and other imaginary evils. And this holds all of us back. Unused resources abound, human needs go unmet, and the vast majority of Americans believe that ‘There Is No Alternative’ (TINA). Or, as Warren Mosler says, “Because we fear becoming the next Greece, we’re turning ourselves into the next Japan.”

There is an alternative. And it begins with an understanding of the monetary system. The cat is already out of the bag. Chairman Bernanke confirms it. Money is no object.

Posts by Stephanie Kelton

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About the Author

kelton Stephanie Kelton is Associate Professor of Economics at the University of Missouri-Kansas City, Research Scholar at The Levy Economics Institute and Director of Graduate Student Research at the Center for Full Employment and Price Stability. Her research expertise is in: Federal Reserve operations, fiscal policy, social security, health care, international finance and employment policy. She writes at New Economic Perspectives. Full bio is available here.

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5 Responses to Federal Reserve: Can We Run Out of Money?

  1. Charles Kondak says:

    I understand Professor’s Kelton’s view having recently written:

    “It is bad enough that there are powerful interests aligned in keeping the status quo Federal Reserve system, but what is more disconcerting is that the general public is so willing to sacrifice itself on the altar of budget cuts and shared sacrifice. There is a way to dispense with the deficient/debt hysteria sweeping the country, fanned by the very same powerful interests who stand to benefit from it. Wall Street in the case of privatizing SS and health insurance companies with Medicare (Ryan proposal).

    First, the Treasury “prints” $15 trillion (size of the national debt) and transfers it to the Federal Reserve and deposits it in an account with the FED. I can hear the screaming already, that printing money is inflationary. People act irrationally when they hear the phrase “print money”, they equate the act of transferring money from one Government agency to another as inflationary. But money created by the Treasury and transferred to a FED account sits in a vault, actually as a number on a ledger and is not in the economy chasing actual stuff bidding up prices.

    I hope you guys are with me so far. Now, as those bonds owned by those little yellow men hiding under the bed become due it is paid out of the $15 trillion dollar fund the Treasury created at the FED.

    It’s full employment not deficits when there is so much productive slack in the economy that matters!!! The debt/deficit is just a number on a balance sheet somewhere until it is spent into the economy. Of course, we can’t deficit spend endlessly or there will be inflation which is really not a change in the Consumer Price Index as most think. Inflation occurs past the point where the economy is making all the stuff it can produce. Boy, some may be going ballistic with that definition of inflation. But think about it. In the off season motel rooms are at their cheapest. As more guests enter the picture, as the “peak” season approaches, prices begin to increase. During the peak season prices reach their highest. When every guest can get a room and no rooms are vacant we have reached a price where full utilization is reached. If one more guest enters the picture they begin to bid up the price and the game of musical chairs begins with prices being bid higher and higher – inflation.

    When we reach the point where the economy is making all the stuff it can and inflation begins to surface taxes are used to drain money from the system. Taxes in this world are not be so much to fund the Government but to regulate inflation. Jiggering the tax system to cool inflation in theory makes sense, but imagine trying to raise taxes in the face of inflation. This is where the theoretical runs heads first into the brick wall of political reality. Any thoughts?

  2. Dig Deep says:

    Good points and perspectives.
    My view is that the ultra intervention by the Fed is damaging to our economic system.
    -Not allowing bad debts to clear the system encourages poor management to continue.
    -I don’t think all the reserves sit in some electronic vault w/out effect. The TBTF banks trading operations benefited from the liquidity – that liquidity pumping into risk assets; equities and commodities. Equities self correct (form artificial stimuli) eventually and rising commodity values have the great consequence of higher input costs…margin squeeze for households and businesses. Standard of living erosion…with a low USD market value to boot. Over capacity does keep a lid on wages – and margins. So inflation as defined by wages is under control – but input cost inflation is felt at retail everyday at a steadily increasing rate.

    The more artificial monetary support we allow, the more unsustainable our economic engine becomes. Re-inflating to bubble levels (with debt primarily) got us into trouble in the first place. MMT in practice does allow for unlimited funding….it’s when it is used for picking winners (financialization) and losers (Main Street), we find ourselves edging further away from capitalism and toward centrally planned economies. Friedman is rolling over in his grave.

  3. roger erickson says:

    You have to wonder why this wasn’t universally known, since 1933, when we originally went off the gold-std to a fiat currency std.

    “ECCLES: We [the Federal Reserve] created it.
    PATMAN: Out of what?
    ECCLES: Out of the right to issue credit money.
    PATMAN: And there is nothing behind it, is there, except our government’s credit?
    ECCLES: That is what our money system is.”

    – Federal Reserve Board Governor Marriner Eccles in testimony before the House Committee on Banking and Currency in 1941, during questioning by Congressman Wright Patman about how the Fed got the money to purchase two billion dollars worth of government bonds in 1933.

  4. Malcolm McIntyre says:

    Phew, it’s a relief to discover everything’s okay. Can’t you pass on the good news to the states and counties going broke, retirees who think their savings have been ripped off and the Greeks rioting in the streets. Thanks in advance.

  5. Sebastian Bermudes says:

    Unfortunately there is a simple, but painful answer to this question. Under our current and very dangerous system our government and cannot under any situation run out of money. There is no restrictions on how much cash the Federal Reserve can print up and there is little to no oversight regarding what they do with the money they print.