Where Did the Federal Reserve Get All that Money?

By Stephanie Kelton (h/t Matthew Berg)

Federal Reserve Chairman Ben Bernanke gave his fourth lecture at George Washington University yesterday. Buried in the lecture, beginning at about 19:18 in the video, Bernanke explained where the Fed got the money to “pay for” the assets it purchased as part of its Quantitative Easing (QE) policies.

I remember when the Fed announced the first round of QE. Those who don’t understand Fed operations – think most mainstream economists – went nuts. Many worried that the Fed would be unable to “unwind” its positions (i.e. divest itself of the assets – MBS, Treasuries, etc. – it had purchased) because banks would refuse to swap their nice safe cash for riskier instruments when the economy recovered. Others insisted that QE was “stuffing the market full” of too many dollars and that this, inevitably, would result in hyperinflation.

John Carney just wrote a very nice piece, showing that not only was the Fed able to find buyers for its assets but that markets actually bought them back at a premium. Bernanke addresses the second objection in his remarks below – idle balances don’t chase any goods – but it’s the financing of the asset purchases that I want readers to understand, because this is fundamental to understanding Modern Monetary Theory (MMT).

The Federal Reserve, like any bank, can acquire an asset simply by crediting a bank account. In other words, the bank pays by creating money. As Alan Greenspan explained, the Fed has an unlimited capacity to spend in US dollars. It can pay trillions of dollars with a single keystroke. Here is Chairman Bernanke (Readers can follow is presentation beginning on page 17):

“Now, you might ask the question, well, the Fed is going out and buying 2 trillion dollars of securities – how did we pay for that? And the answer is that we paid for those securities by crediting the bank accounts of the people who sold them to us, and those accounts, at the banks, showed up as reserves that the banks would hold with the Fed. So the Fed is a bank for the banks. Banks can hold deposit accounts with the Fed, essentially, and those are called reserve accounts. And so as the purchases of securities occurred, the way we paid for them was basically by increasing the amount of reserves that banks had in their accounts with the Fed.

So you can see this, here, this is the liabilities side of the Fed’s balance sheet. Of course, assets and liabilities (including capital) have to be equal. So the liabilities side had also to rise near 3 trillion dollars, as you can see.

Now, take a look first, as you look at this, take a look first at the light blue line at the bottom. The light blue line at the bottom is currency – Federal Reserve notes in circulation. Sometimes you hear that the Fed is printing money in order to pay for the securities we acquire. And I’ve talked about that in some, you know, in giving some conceptual examples. But as a literal fact, the Fed is not printing money to acquire these securities, and you can see it from the balance sheet here, the light blue line is basically flat. The amount of currency in circulation has not been affected by these activities.

What has been affected is the purple area. Those are reserve balances. Those are that accounts that banks, commercial banks, hold with the Fed, and they are assets of the banking system and they are liabilities of the Fed, and that’s basically how we paid for those securities. And so, the banking system has a large quantity of these reserves, but they are electronic entries at the Fed. They basically just sit there. They’re not in circulation. They’re not part of any broad measure of the money supply. They’re part of what’s called the monetary base, but again, they’re not, they certainly aren’t cash.

Then there are other liabilities including Treasury accounts and a variety of other things that the Fed does – we act as the fiscal agent of the Treasury. But the two main items, you can see, are the notes in circulation and the reserves held by the banks.”

So ask yourself this question: If the Federal Reserve can create trillions of dollars with a single keystroke, and the Fed is the government’s bank, then why does President Obama claim we’ve “run out” of money? Why have Democrats and so-called progressives supported job-killing budget cuts in the name of “shared sacrifice”? Why are we throwing away the equivalent of $9.8 billion in lost output every single day? Why don’t we do something about our $2.2 trillion infrastructure deficit, 25 million underemployed and unemployed Americans, 100 million Americans in or very near poverty, and so on?

The answer is simple. Most of us don’t understand the monetary system. Instead of deciding how the government should wield its power over the dollar, we live in fear of the ratings agencies, the Chinese, the bond market vigilantes and other imaginary evils. And this holds all of us back. Unused resources abound, human needs go unmet, and the vast majority of Americans believe that ‘There Is No Alternative’ (TINA). Or, as Warren Mosler says, “Because we fear becoming the next Greece, we’re turning ourselves into the next Japan.”

There is an alternative. And it begins with an understanding of the monetary system. The cat is already out of the bag. Chairman Bernanke confirms it. Money is no object.

Follow us on Twitter @stephaniekelton

Proof platinum coin. http://my.firedoglake.com/wigwam/2011/08/09/greenspan-the-united-states-can-pay-any-debt-it-has-because-we-can-always-print-money-to-do-that/

35 responses to “Where Did the Federal Reserve Get All that Money?

  1. 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.

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  3. 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.

    • 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.

  4. 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.

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

    • 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.

  6. 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.

  7. 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

  8. Stephanie Kelton


    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.

  9. 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.

  10. Stephanie Kelton

    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

    • 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.

      • 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.

        • 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.

  11. 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?

  12. 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.

  13. 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.

  14. Pingback: Where Did the Federal Reserve Get All that Money? | Financial News 24

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

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

  17. 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.


  18. 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.

  19. 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.

  20. 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.

  21. 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.

  22. 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

  23. Adam Smith Jr. Jr.

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

  24. 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.

  25. 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?

  26. 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?