Money creation

Date posted: December 13, 2010

There has been a lot of talk recently about money, and specifically the money the Federal Reserve is planning to create to stimulate the economy. How is this done? Does the Federal Reserve really have the power to flip a switch and generate money? N.C. State University economist Mike Walden answers.

“Well, it would be more like push a computer button … and create more money. Most of this is done electronically, so it is not as if they go to a printing press and print out this money. But what the Federal Reserve can do is take an electronic account — like you and I have electronic accounts at the bank at which we do business that has the amount of money we have on deposit there.

“Well, what the Federal Reserve can do is take their electronic account and say, ‘Hey, we need to add some money.’ And they just key in some more dollars, and, poof, they have more money. And usually the way the Federal Reserve gets this money into the system is they then use that money they have created to go out and buy things — usually financial things, like treasury securities or other types of investments. Generally they do it for the banking system, although they might do it outside the banking system.

“Now in normal times we would want the money supply to grow with the growth in the economy, because the bigger the economy the more transactions they are going to do. But we often see the Federal Reserve print even more money during bad economic times. It is a way for them to try to prime the pump to get there to be more spending in the economy. In fact they are doing that right now. The down side, however, is that if they keep doing this — and especially if and when the economy does revive — you may have that old classic phrase ‘too much money chasing too few goods and services,’ which leads to higher inflation.”

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