FED is not printing money

It was is common to colloquially refer to  quantitative easing by the Fed – specifically, QE2 – as “printing money”. However, that’s not exactly right.  So what exactly did the Fed do? Well, instead of printing the green paperbacks, the Fed credited the accounts of the banks that are members of the Federal Reserve system. This- in econ talk- is also known as expanding  the Fed’s reserve balances. These reserves are different from printing money because they’re are loaned out to the banks and do not create new money, or M1 in the short-run. With that said, any bank who’s a recipient of such credits could at any time redeem them for real currency. Via FRED, I’ve sketched a composite graph illustrating money in circulation (blue) and reserve balances of the Fed (red). The graph clearly shows a precipitous rise in reserve balances in the 2nd-half of 2008, accompanies by a sober rise in money supply. These two variables essentially offset each other. Note: The rise in reserves during 2011 is attributed to QE2.

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Money in circulation (blue) & Reserves (red)

To understand this distinction better, we need to look at the past 10 years. Prior to 2008, the interest rate on excess reserves was virtually zero; this forced the banks to do two things to make a little profit off these reserves: (1) cash withdrawals OR (2) exchange them with other banks i.e. interbank transfers for a small profit margin. This all came undone once the Great Recession hit. After the bail-outs and averting systemic risk, the Fed introduced interest rates on excess reserves to incentivize the banks to hold on to the reserves, and in effect cushion themselves against the forthcoming period of economic uncertainty. Unlike pre-2008, in the present system as the graph shows, the banks are earning financial rate of returns on their reserves and have no desire to redeem these reserves for actual currency. This consequently has created a huge lag in the overall money supply.

GOP and the myth of fiscal conservatism

I’m always surprised when folks on the right tout the GOP as a party of small and limited government. This runs counter to the historical time-series data.  Via Matias Vernengo at the Naked Keynesianism blog, I have imported a noteworthy chart below which attempts to put everything in perspective. The chart indicates that the federal outlays (expenditures) as a % of GDP have consistently gone up during the Republican administrations and reversed under the Democrats. The only exception is the first two years of the Obama admin., where the spending grew during 2008-2009 due to the shortfall in revenue, up-tick in automatic stabilizers, i.e. unemployment insurance, etc., and of course the stimulus.  However, this preliminary growth in spending fell in 2010 (despite the continuation of the two wars, the Libya campaign and the offshore wars in Pakistan and Yemen). However, this raises a red flag:  At a time when we require ambitious deficit spending to offset the shortfalls in private investment and spur aggregate demand, the chart shows that the Obama administration has succumbed to the deficit hawks.

Also note, the exponential rise in defense spending during the Republican administrations and an unchecked rise in the healthcare spending due to the healthcare cost inflation. If the Republicans and Democrats are serious about retiring the nation’s debt, I hope they’re ready to tame the costs of defense and healthcare. We need to scale back our foreign ambitions, and make important patches to the healthcare law that would insure more discipline in the health-care market.

Welcome!

I’m a graduate student in economics. My field of specialization is development economics; specifically, capital mobility, foreign direct investment and international trade. This blog is intended to highlight new research in the field of macroeconomics and development. However, what this blog is not intended to do is to provide in depth and wonkish analysis, for that, go to one of the heavy-weights. I want to do this in the little time I could squeeze out between my courses and course exams. So, feel free to hold me to my extremely low standards.