35 responses

  1. Dan Kervick
    March 30, 2012

    Great piece Stephanie.

    Maybe people don’t understand their own monetary system because a lot of people in power don’t want them to understand it? It’s like letting the serfs know that they actually own the deed to the estate, which is locked up in safe in the treasure house.

    Also, since most of us are currency users managing our own finite accounts with the financial constraints that come with being a currency user, it’s hard for us to “think like a government”. People naturally apply their own experience.

    I still think that the Bernanke explanation, as simple and straightforward as it is, is misleading in a way. Because money in circulation is officially counted as a “liability” of the Fed, some people will watch his explanation and say, “Oh my God! Ben Bernanke just created $2 trillion in US debt with a few keystrokes! He’s a madman!”

    Thus following QE and QE2 we got all sorts of hysterical articles about how the Fed might go “bankrupt” because of its skyrocketing liabilities, and how the Treasury might have to bail the Fed out.

    So I think it’s good if we can get people to see that the liability of a central bank is nothing like the IOUs of a firm or household with a regular balance sheet and a finite stock of monetary wealth.

  2. Caol Acain
    March 30, 2012

    Good post Stephanie. Quick question:

    If QE is really just a crediting of bank’s reserves and loans are made independently of reserves (like you said recently, when do loan officers check reserve balances?), then is there an irrational hope that by increasing banking reserves, the Fed can induce more lending?

    Also, why does Bernanke think that by reducing the available supply of Treasuries in the market, he can direct more investment into things like corporate bonds or non-agency RMBS? In a stress scenario, is it really that meaningful? Isn’t the real problem the increase in demand for cash? I don’t see how QE mitigates that “demand for cash” problem.

    • Dan Kervick
      March 30, 2012

      Hopefully Bernanke will write his memoirs some day so that we can all find out what he really thought he was up to. My guess is that he will say that he knew QE does not have any significant effects from a purely instrumental point of view, but that a lot of prominent people who didn’t understand the monetary system were calling for it. So he decided that as an official with major responsibility for public expectations and confidence, he had to go ahead with it.

      If the tribe is asking for a rain dance, the shaman has to do a rain dance.

  3. Jonf
    March 30, 2012

    It is a pity really. $9.8 Billion lost per day, and as I recall, Bill said that was conservative. Think of all the good we could do with that money. Think of all the good we could do by just hiring people at a minimum wage through a JG. But it seems we can’t convince the people who matter to do the right thing. Now we face the prospect of the Ryan budget which will become fact if and when Romney is elected.

  4. Tyler
    March 30, 2012

    I’ve tried to explain this stuff to my MBA-having friend, to no avail. He follows the Peterson Institute on Twitter.

    • Dan Kervick
      March 30, 2012

      One thing that sometimes works with folks like that is if you point out how public sector deficits are needed to help the private sector dig out and deleverage. Since they’re justifiably worried about household debt burdens, pointing them toward understanding the sectoral balances sometimes helps.

      Mike Norman had a post today in which he pointed out that increased household spending is not being matched by increased household income. So households are once again being forced to take on debt to meet their ordinary needs. Government austerity is to blame.

      • Tyler
        March 30, 2012

        Thanks very much for your response. Unfortunately, my friend has become a Hayekian. He wasn’t one before he went to SAIS. I think he would have been better off not attending.

      • Dan Kervick
        March 30, 2012

        I think there are support groups for people in your predicament.

      • Tyler
        March 31, 2012


  5. D R
    March 30, 2012

    There’s a big difference between Treasury showing a profit on the deal than the Fed showing a profit on the deal. With the Fed, one has to consider the opportunity cost.

    Note, for example that a mere $1.5-$2 trillion at 4.5% (the 30-year rate in mid-2008) would yield $300-400 billion in interest over four years. Plus, the Fed gets to pick and choose how to realize gains and losses.

    Take a security which yields 10% half the time, and loses 10% the other half of the time. Now suppose I buy $1 trillion of such securities. After one year, cash out the winners, sending you the $50 billion “profit” and reinvest the rest.

    From your perspective, I’ve sent you $50 billion on $1 trillion (even better than the 4.5% on Treasuries!) But I’ve actually only broken even. In essence, I’ve lost $45 billion I should have made in 30-year bonds.

  6. Marcello
    March 30, 2012

    Hi Dan;
    Also, since most of us are currency users managing our own finite accounts with the financial constraints that come with being a currency user, it’s hard for us to “think like a government”. People naturally apply their own experience.

    from Italy

    • Dan Kervick
      March 30, 2012

      Yes, it’s very hard to get over this for a lot of people.

  7. Stephanie Kelton
    March 30, 2012


    It’s not my point, it’s Carney’s. The Fed hands its profits over to the Treasury anyhow. Carney’s piece shows us why there’s been a giant sucking sound (as Ross Perot used to say) as a result of QE and why there is a strong DEflationary aspect to the policy.

  8. D R
    March 30, 2012

    I don’t understand.

    My point is that the profits don’t necessarily exist at all. Suppose the Fed creates $2 trillion in cash and swaps it for $2 trillion in “illiquid” (read: overpriced) assets. Then it cashes out $200 billion in profits, but doesn’t realize its losses. How is that deflationary?

    Actually, the profits don’t matter at all. Suppose the value of the $2 trillion in assets dropped to $0. Even then, how is that deflationary? In that worst-case scenario, the Fed transforms $2 trillion in junk into $2 trillion cash.

  9. Stephanie Kelton
    March 30, 2012

    None of what you describe is deflation. The deflationary side of QE comes from the loss of (interest) income. The nearly $80B that was removed from private sector incomes and turned over to the Treasury last year. See: http://moslereconomics.com/2011/01/10/fed-turns-over-record-78-4-billion-profit-to-treasury/
    and here http://www.creditwritedowns.com/2012/01/chart-of-the-day-permanent-zero-and-personal-interest-income.html

    • D R
      March 30, 2012

      Right. But those were risky assets, and I’m saying that this is not a full accounting.

      Do we know what kind of losses the Fed has yet to realize?

      Say you paid $2 trillion in risky assets with a face value of $2.5 trillion, which may pay 10% interest or may pay nothing and lose 50% of its value. Say it’s 50-50, but you’re levered 20:1– owing $1.9 trillion in debt. You’re either going to make $200 billion or lose $200 billion… on your $100 billion gamble.

      Now the Fed buys the stuff off you for $2 trillion and you pay off your debt. You realize no gain, but you weren’t expecting to, anyway. You’re more liquid than before, with far less risk.

      The Fed, however, realizes $125 billion in interest on $1 trillion in assets, which it dutifully turns over to Treasury. What’s not mentioned is the $125 billion loss on the rest. Sure, the $125 billion would have gone to the you, and is now at Treasury. But there’s a $125 billion loss at the Fed that also would have gone to you.

      And that assumes the Fed pays you fair value for those assets, which is pretty unlikely. Suppose the market price for your assets was falling– maybe you would have only realized $1.8 trillion if you sold to anyone else. That doesn’t matter to the private sector, but that’s still another $200 billion subsidy to the private sector.

      And so on.

      • Dan Kervick
        March 30, 2012

        Suppose not a single one of those assets paid a dime. What has the Fed lost? Suppose every one of them paid handsomely? What has the Fed gained? It doesn’t matter to the Fed one way or another.

        It only matters to the debtors in the private sector. If the assets pay off $10 trillion, that means some group of people in the private sector for whom the assets were liabilities just shipped $10 trillion to the Fed. If the debtors all default, each and every one, that means they all kept their money and sent nothing to the Fed.

        It matters not a whit to the Fed. The Fed never gets richer or poorer in monetary terms, since it is the source of all the money in the first place. But arguments can be made that it does matter to the public purposes for the sake of which the Fed purchased the assets in the first place. Maybe the Fed wants all those debtors to pay up, because otherwise the money the Fed paid for the assets plus the money the debtors keep results in inflation. Or maybe public purpose is better served by letting the debtors all keep their money and having the Fed extinguish the debts.

      • D R
        March 31, 2012

        Your argument is that the Fed collecting interest is more deflationary than the Fed forgiving the debt? OK, fine. As long as you ignore the fact that the Fed would probably wind up running tighter policy elsewhere.

        Which is not to say I could care less. From a purely monetary standpoint, I would rather see forgiveness and risk subsequently tighter policy.

        But I also strongly suspect the show of “profits” is nothing more than a PR move, and has no actual deflationary impact whatsoever.

  10. DrBernard
    March 30, 2012

    Thanks for your clarity. Now, can you get Bernanke to go “manufacturers direct” and keystroke into one bank account of each adult citizen $20,000.00 in “reserves”–so that We the People have a little cushion for a rainy day? Isn’t this more orderly than throwing cash from a helicopter? Don’t we deserve the same financial support per annum that the average prisoner in the the U.S. gets?

  11. Schofield
    March 30, 2012

    Now, can you get Bernanke to go “manufacturers direct” and keystroke into one bank account of each adult citizen $20,000.00 in “reserves”.

    Well the short answer is he could, or some such sum, as the tax free dollar part of every body’s wage and as part of a Job Guarantee scheme for those who wanted to work. The problem is neither the Democrat or Republican politicians can really be bothered to ensure full employment because they’re sitting pretty with their government wages and need to pay lip service to hallowed anti-government rhetoric.

  12. Andy
    March 30, 2012

    Thanks Stephanie
    Just wanted to say I enjoyed yours and Bills interview on KCUR.
    You both came across really well as did the presenter
    I’m surprised you’re not linking to it.

  13. Joe
    March 31, 2012

    I’d like a link to that interview, if you please!

  14. Andy
    April 1, 2012

    Sorry. Should have left the link. NEP have beaten me to it and its now on the main page

  15. chris
    April 14, 2012

    Hi Stephanie,

    In order to increase capital, commercial banks need to earn more on their assets than they spend on their liabilities.
    Can you tell me about the cost of the funds that the banks have on reserve at the fed in relation to how much they earn on those funds? Are the reserve accounts like savings or checking accounts at a commercial bank that can be withdrawn rather quickly, or are they more like a CD that has some sort of term before they can be withdrawn? If the commercial banks can always earn more at the fed than it costs for the funds they put there, why don’t they just put all of their assets at the fed and not make any loans at all? Conversely, if it costs more for the funds than they are paid by the fed, why do they put any funds there at all?

    Another question; if the federal reserve really has an unlimited ability to spend in US dollars as stated by Alan Greenspan, what restrains it from spending enough to acquire all of the assets in the US, or even the entire world? I know this is an extreme example, but as a thought experiment your explanation would be enlightening.


  16. Bob Fishell
    September 14, 2012

    I’ve got a very conservative Facebook friend who is always freaking out about where the country is going to get the money to pay for stuff. I tell him, don’t worry – we can always print more. He thinks I’m ribbing him. He doesn’t realize I’m serious.

  17. Luke Lenzi, Esq.
    September 19, 2012

    The reason why the Fed doesn’t deposit $20,000 in each American’s bank account isn’t because they are slothfully resting on their meager governmental wages.

    Theoretically, the thesis discussed above makes for great classroom discussions. A great tool for massaging the ego of the sophists and pacifying their initiated disciples. A cultish dogma. When reason is critically applied, the theory is exposed as fraudulent.

    Of course, if the parties could create wealth from nothing, than the parties and their financial handlers, in the interests of securing their “fat government wages” and power, would have long ago eliminated all federal taxes and greatly expanded the federal government subsidies far beyond their current existence. Taxation, if it existed, would exist solely as a draconian means of laying waste to political enemies and a disruptive population. In fact, this strategy would have been implemented by nations long ago. Unless, you are naive enough to believe that we are living in a time of supreme intellectual enlightenment.

    Think critically, if the current power players could increase the nation’s wealth by manipulating the quantitative nature of our currency, and extinguish liabilities with a keystroke, than why haven’t they? Why would they have allowed the circumstances to degenerate and threaten their power base? The longer they wait, the more their power is threatened by other world powers strategically position their currency against the dollar.

    Unless, of course, your position is that they are ignorant. The same people that espouse such a policy, when it comes to action, seem to pull back. The same people who have eliminated federalism and globalized their power. The same people who use the tax code and international law to eliminate any real taxation and liability by suit on their wealth. While at the same time deceiving the mob into believing that either party is trying to liberate the mob from crushing taxes with the promise of a better life.

    Open your eyes. Observe the conflict of interest and criminality. It is merely another method for transferring the wealth of a nation to its aristocracy while simultaneously oppressing the masses.

  18. Steven
    December 13, 2012

    In the end, real wealth is created by people making useful products, and with luck doing it more efficiently than in the past. Yes the Federal Reserve has an infinite capacity to change the balance sheets of banks or governments on paper, which can help at the margins for a time, dampening shocks and so on. But governments are really only good at creating distortions (and then shortages). If the Fed creates abstractions that don’t in the end result in actual people doing useful things then they are introducing distortions that will one day have to be worked out (at a price in human suffering).

    Or I could put this another way — a high level of government spending is not needed for economic success with low unemployment. The Fed is enabling something we don’t really need.

  19. David
    January 3, 2013

    I agree that while the above article is interesting in classroom discussions, it is ultimately misleading on a practical level. Like the law of conversation of energy in physics, any monetary policy that does not result in the creation of real wealth will always result in zero sum gain in terms of total wealth. While the Feds may be able t manipulate the system with a variety of tactics, at most what they’ve done is time shift the current economic impacts so that the market (the real market) won’t get knocked out of it’s feet too quickly. But eventually there is a price and it has to be paid, either via inflation, deflation, or real wealth creation by the market. The feds are not magicians, they cannot create real wealth via a keystroke.

  20. Mark
    March 4, 2013

    It is comical to hear people educated beyond contact with reality explaining The Monetary System as if it existed without contact with material goods or scarcity. Seems they’ve overlooked the connection and understand the monetary system without understanding money.

    Refutation of Bishop Berkeley -
    After we came out of the church, we stood talking for some time together of Bishop Berkeley’s ingenious sophistry to prove the nonexistence of matter, and that every thing in the universe is merely ideal. I observed, that though we are satisfied his doctrine is not true, it is impossible to refute it. I never shall forget the alacrity with which Johnson answered, striking his foot with mighty force against a large stone, till he rebounded from it — “I refute it thus.”
    James Boswell: Life of Samuel Johnson book 3

  21. Adam Smith Jr. Jr.
    August 4, 2013

    Buying time. Kicking the can down the road. The traditional method. Simple enough, works for the present and better times may be ahead.

  22. Tom Graham
    December 11, 2013

    There is a hole the size of a bus in this theory.
    What you’ve just said is that
    1) The Fed created money (electronic credit) in the account of the bank that sold them the mortgage backed security.
    2) The bank is required to keep that credit in the Fed as excess reserves (which for the last few years have also earned interest)

    So how is that stimulating the economy? The Fed creates 85 billion of base money that has to be held in reserve. No one gets to spend anything, there is no additional liquidity. This theory is completely wrong.

  23. FThomasCain
    January 30, 2014

    Whether it is currency in circulation or fiscal assets added to some account, they are both debt – backed only by the good faith of the government – not gold or anything tangible. Where does all the FED debt of 86 billion per month GO? Certainly not to the national debt of 17 trillion or the yearly deficit – Tooth Fairy account?

  24. Paul Lebow
    March 7, 2014

    Explain Greenspan please. He stated that the Fed adds money to the commercial bank’s reserves but that they are not part of the money supply. But, aren’t these reserves available for conversion to “cash” in the form of a new bank loan?

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