Is the Fed Printing Too Much Money?

For as long as I can remember people have referred to the Fed printing money-usually when they disapprove. The implication is that printing money is inflationary.

I've always assumed that those who use that terminology understood that "printing money" shouldn't be taken literally. Nowadays, I'm not so sure. Several financial talking heads I've heard recently sound like they mean it literally. Often the context has been whether the Fed might buy longer-term treasuries.

While most of you know this, I feel compelled to point out that the Fed doesn't literally print money. That is done by the Bureau of Engraving and Printing, which is under the Treasury Department. The amount of printed or paper money that gets into circulation is not determined by the Bureau, the Treasury, or the Fed. It is determined by the preference of the public for holding currency as opposed to deposit accounts in financial institution.

If the public collectively decides it wants to hold more of their money in the form of currency-as they normally do as the Christmas season approaches-they simply cash more checks at their banks and take the currency. The proportion of the money supply (however we define it) held in paper money rises relative to the proportion held as deposits. More checks cashed at banks are paid for by the public with deposit balances. The banks will, in turn, order more currency from the Federal Reserve, paying for it by drawing down their reserve balances on deposit at the Fed. When the Fed's own inventory of currency gets low, it orders more from the Bureau of Engraving and Printing and pays for it by increasing Treasury deposits at the Fed. So the amount of currency printed is up to the public.

I should mention that when paper money gets too worn or damaged, the Fed destroys it and replaces it with new inventory from the Bureau. That means there is a relatively steady printing of new currency even when the total money supply-currency plus certain deposits-isn't growing rapidly.

The Fed influences the creation of money while the public determines the portion to be held in currency. Substituting "creating money" for "printing money" would correct many assertions that are made. However, the term "creating money" may also be misunderstood by those who aren't familiar with the process.

The Fed normally "creates money" by buying short-term government securities in the open market. The seller of the government securities gives up the securities and gets more deposits in his bank. He traded one asset for another. The banks owe more deposit liabilities to their customers, offset by more reserve deposits at the Fed-when it deposited the check received from its customer. The Fed has more government securities on the asset side of its balance sheet offset by more reserve liabilities owed to the banks. Everybody's balance sheet balances. New money was created in the process, but no net new assets or wealth. New money was created-not printed. If its growing deposits (money supply) causes the public to rebalance into more currency, more money might then be "printed," but it will be paid for with deposit money.

The question of whether the Fed is creating too much money these days is a different question to be dealt with separately.

Comments (3)

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  1. Ray Stone says:


    Excellent note "Is the Fed Printing Too Much Money?" I will make sure students in my Money & Banking class read.

    All the Best for 2009,

    Ray Stone

  2. Gary Haubold says:

    Excellent, post.

    When you take up the question of whether or not the Fed is creating too much money, I hope you’ll have a comment or two on the other catch-phrase of alleged Fed irresponsibility: “monetizing the debt”.

    Considering that the Fed is now actively purchasing many securities outside the normal pool of t-bills, I suspect that “monetizing the debt” will be a common topic of misunderstanding throughout 2009.


    Gary Haubold

  3. Bill says:

    If new money is created without new assets or wealth doesn’t this cause inflation?