Most Popular
1. It’s a New Macro, the Gold Market Knows It, But Dead Men Walking Do Not (yet)- Gary_Tanashian
2.Stock Market Presidential Election Cycle Seasonal Trend Analysis - Nadeem_Walayat
3. Bitcoin S&P Pattern - Nadeem_Walayat
4.Nvidia Blow Off Top - Flying High like the Phoenix too Close to the Sun - Nadeem_Walayat
4.U.S. financial market’s “Weimar phase” impact to your fiat and digital assets - Raymond_Matison
5. How to Profit from the Global Warming ClImate Change Mega Death Trend - Part1 - Nadeem_Walayat
7.Bitcoin Gravy Train Trend Forecast 2024 - - Nadeem_Walayat
8.The Bond Trade and Interest Rates - Nadeem_Walayat
9.It’s Easy to Scream Stocks Bubble! - Stephen_McBride
10.Fed’s Next Intertest Rate Move might not align with popular consensus - Richard_Mills
Last 7 days
Stock Market Brief in Count Down to US Election Result 2024 - 3rd Nov 24
Gold Stocks’ Winter Rally 2024 - 3rd Nov 24
Why Countdown to U.S. Recession is Underway - 3rd Nov 24
Stock Market Trend Forecast to Jan 2025 - 2nd Nov 24
President Donald PUMP Forecast to Win US Presidential Election 2024 - 1st Nov 24
At These Levels, Buying Silver Is Like Getting It At $5 In 2003 - 28th Oct 24
Nvidia Numero Uno Selling Shovels in the AI Gold Rush - 28th Oct 24
The Future of Online Casinos - 28th Oct 24
Panic in the Air As Stock Market Correction Delivers Deep Opps in AI Tech Stocks - 27th Oct 24
Stocks, Bitcoin, Crypto's Counting Down to President Donald Pump! - 27th Oct 24
UK Budget 2024 - What to do Before 30th Oct - Pensions and ISA's - 27th Oct 24
7 Days of Crypto Opportunities Starts NOW - 27th Oct 24
The Power Law in Venture Capital: How Visionary Investors Like Yuri Milner Have Shaped the Future - 27th Oct 24
This Points To Significantly Higher Silver Prices - 27th Oct 24
US House Prices Trend Forecast 2024 to 2026 - 11th Oct 24
US Housing Market Analysis - Immigration Drives House Prices Higher - 30th Sep 24
Stock Market October Correction - 30th Sep 24
The Folly of Tariffs and Trade Wars - 30th Sep 24
Gold: 5 principles to help you stay ahead of price turns - 30th Sep 24
The Everything Rally will Spark multi year Bull Market - 30th Sep 24
US FIXED MORTGAGES LIMITING SUPPLY - 23rd Sep 24
US Housing Market Free Equity - 23rd Sep 24
US Rate Cut FOMO In Stock Market Correction Window - 22nd Sep 24
US State Demographics - 22nd Sep 24
Gold and Silver Shine as the Fed Cuts Rates: What’s Next? - 22nd Sep 24
Stock Market Sentiment Speaks:Nothing Can Topple This Market - 22nd Sep 24
US Population Growth Rate - 17th Sep 24
Are Stocks Overheating? - 17th Sep 24
Sentiment Speaks: Silver Is At A Major Turning Point - 17th Sep 24
If The Stock Market Turn Quickly, How Bad Can Things Get? - 17th Sep 24
IMMIGRATION DRIVES HOUSE PRICES HIGHER - 12th Sep 24
Global Debt Bubble - 12th Sep 24
Gold’s Outlook CPI Data - 12th Sep 24

Market Oracle FREE Newsletter

How to Protect your Wealth by Investing in AI Tech Stocks

Fed Debt Monetization- Creating Credit Out of Thin Air

Interest-Rates / Quantitative Easing Mar 24, 2009 - 02:19 AM GMT

By: Paul_L_Kasriel

Interest-Rates Best Financial Markets Analysis ArticleLast week the Fed announced that it would purchase $300 billion of longer-maturity Treasury securities. The mainstream media got all excited, talking about the Fed "printing money." But the Fed figuratively "prints money" or creates credit whenever it acquires assets - loans or investments. For example, when the Fed purchases a mortgage-backed security, it pays for the security simply by crediting the deposit (reserve) account of the security seller's bank.


The seller's bank, in turn, credits the seller's deposit account. If the seller happens to be a bank, then just the bank's reserve account gets credited. Either way, the Fed is figuratively creating credit and, in the case when the seller of the security is a nonbank, money "out of thin air." To create credit out of thin air, it does not matter whether the Fed purchases a mortgage-backed security or a Treasury security. Moreover, when the Fed lends to banks through its discount window, it also is creating credit out of thin air. In fact, when the Fed pays its employees, it is creating credit and money out of thin air.

Suppose the Treasury issues an additional $100 billion of securities and the Fed purchases an additional amount of mortgage-backed securities. Is the Fed "monetizing" the Treasury debt? Directly, no. Indirectly, yes. Funds are fungible. All else the same, the Treasury's increase in the supply of securities is offset by a decrease in the amount of mortgage-backed securities as a result of the Fed's purchase. So, the amount of securities to be held by the non-Fed public is unchanged. Indirectly , then, the Fed has monetized the increased debt issuance by the Treasury.

Getting back to the Fed's announcement last week, not only did it say that it would purchase $300 billion of longer-maturity Treasury securities, but it also would purchase an additional $750 billion of mortgage-backed securities and an additional $100 billion of direct debt of government-sponsored agencies (e.g. Fannie and Freddie debt). So, the Fed announced "monetization" in an amount of $1.15 trillion, all else the same. But wait, there's more. The Fed also has begun another monetization program via the T erm A sset-backed securities L oan F acility (TALF). TALF currently is permitted to provide up to $1 trillion of new credit to the financial system - thus, another $1 trillion of monetization.

From December 2007 to December 2008, Federal Reserve Bank credit more than doubled, increasing from about $877 billion to $2.2 trillion. Mama mia , that's a lot of monetization! But a sizeable portion of the increase in Fed credit just ended up as idle excess reserves on the books of banks and other depository institutions. Federal Reserve Bank credit minus excess reserves went from $875 billion in December 2007 to almost $1.5 trillion in December 2008 (see chart below). Just as the non-bank public's demand for money to hold has increased in the past year, banks' demand for "money" or reserves to hold also has increased. Had the Fed not satisfied both the banks' and the non-bank public's increased demand for money by creating more of it, economic activity would have been even weaker than it was.

Chart 1

In the coming months, the federal government is going to be increasing its debt issuance to finance its increased spending as a result of the recently-passed fiscal stimulus program. The Congressional Budget Office is forecasting a federal budget deficit for fiscal year 2009 of about $1.8 trillion. As mentioned above, the Fed is on course to create about $2.15 trillion of new credit in the months ahead. All else the same, the Fed's monetization of debt through the purchase of mortgage-backed securities, Treasury securities or through the TALF program in conjunction with the federal government's increased spending will generate stronger economic activity. If the increased federal spending were being funded with increased taxes, then those paying higher taxes would cut back on their spending as the federal government increased its spending.

Net, net, there would not be much increase in total spending. The same would hold true if the federal government's increased spending were being funded with increased Treasury debt purchased by the non-bank public and not offset by Fed purchases of some kind of debt. But if the Fed purchases some kind of debt in amounts equal to the federal government's increased debt issuance, then the federal government can increase its spending without any one else having to cut back on his or her spending. In the short run, this will boost real economic activity. Of course, farther down the road, this will increase the rate at which prices rise - prices of goods, services and assets. Ben Bernanke's "money-dropping" helicopter has been replaced by a C-5 Galaxy transport!

Paul Kasriel is the recipient of the 2006 Lawrence R. Klein Award for Blue Chip Forecasting Accuracy

By Paul L. Kasriel & Asha Bangalore
The Northern Trust Company
Economic Research Department - Daily Global Commentary

Copyright © 2009 Paul Kasriel
Paul joined the economic research unit of The Northern Trust Company in 1986 as Vice President and Economist, being named Senior Vice President and Director of Economic Research in 2000. His economic and interest rate forecasts are used both internally and by clients. The accuracy of the Economic Research Department's forecasts has consistently been highly-ranked in the Blue Chip survey of about 50 forecasters over the years. To that point, Paul received the prestigious 2006 Lawrence R. Klein Award for having the most accurate economic forecast among the Blue Chip survey participants for the years 2002 through 2005.

The opinions expressed herein are those of the author and do not necessarily represent the views of The Northern Trust Company. The Northern Trust Company does not warrant the accuracy or completeness of information contained herein, such information is subject to change and is not intended to influence your investment decisions.

Paul L. Kasriel Archive

© 2005-2022 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Post Comment

Only logged in users are allowed to post comments. Register/ Log in