links for 2007-09-23
We Would All Be Better Off If the Washington Post Just Stopped Printing Tomorrow

"Helicopter Ben"? Jim Hamilton Says: Not Really

Jim Hamilton writes:

Econbrowser: Money creation and the Federal Reserve: There seem to be some misconceptions about the monetary consequences of actions that the Federal Reserve has taken to address liquidity needs.... I hope in this post to get beyond these sound bites, beginning if I may with some details of the process whereby money is created in the United States. Where did the cash in your wallet come from? Presumably you got it from your bank or ATM. And the reason that the bank was willing to give you that cash was that you already had deposits in an account with the bank, which were in effect credits to obtain cash when you wanted it.

And where did your bank get that cash? If it is a member of the Federal Reserve, your bank got it from a Federal Reserve Bank... your bank had deposits in an account with the Fed, that give it credits to obtain cash when it wants it.... And where did those reserves come from?... the Fed purchased Treasury bills... paying for them by creating new reserves in the dealers' banks. The Fed now is the owner of the Treasury bills, and those banks now have new reserves, which they could use to obtain new dollar bills, if they desired.

To follow what's happened over the last 6 weeks, it's necessary to add a few details to this basic story. For day-to-day fine-tuning of interest rates and the money supply, the Fed usually does not use outright purchases of Treasury securities, but is more likely instead to rely on repurchase agreements... on any given day the Fed's outstanding repos have created reserves and thus potential dollars in circulation... for the week ended August 8, just before the summer fireworks... the Fed held $791 billion in Treasury securities and $19 billion in repos....

Beginning August 9, the Fed aggressively used repos.... The hundred billion dollar figure that some people use comes from adding together each day's repo operations, which is a completely nonsensical calculation. At the height of these operations (the week of August 9-15), Fed repos created an average of $18 billion in new daily reserves....

[W]hat exactly happened to that $18 billion while it was in the banking system? The answer is-- absolutely nothing. Banks simply held these funds as excess reserves, with nobody withdrawing a single dollar bill. This tremendous increase in banks' desires to hold reserves beyond the amount that they were required was one of the remarkable aspects of this situation and the primary reason that the Fed needed to conduct such repo operations in the first place... reserve balances are now right back where they were on August 8, and currency in circulation is in fact $3 billion lower than it was. The Fed has done its job, and the kvetchers have done theirs....

Now, I realize that this explanation may not be as entertaining as the whole Helicopter Ben meme. But on the other hand, it may be a whole lot more accurate...

Comments