Plain Sense Economics

“If the Federal Reserve is printing all these billions and trillions of dollars, won’t we suffer from inflation?”

I get asked this question a lot lately. First, despite the inference of the video provided by the Bureau and Engraving and Printing (see below), the Fed has not been running the money printing presses for extra shifts in the past few months. Instead the Fed can buy U.S. Treasury bills on the open market, and can find a number of other ways to pump money into the economy. The way the money gets created is that the Fed credits the account of securities dealers, banks, and other institutions – each of which have accounts at various Fed district banks. So the balance on these accounts is higher, which gives banks in particular the freedom to lend out more more or somehow make use of the cash. And when the Fed and other policy folk measure the amount of money in circulation they count not only hard currency, but also the balances in checking and other demand deposit accounts.

So, now that we know that money isn’t really being printed, we still need to be concerned by the significant increase in money (represented by currency and checking account balances) injected by the Fed. The inflation concern is real and important. It is a concern not lost on Federal Reserve officials. There is no question that in normal times a significant increase in the money supply usually leads to inflation.

This article in today’s Wall Street Journal explains what has been happening, and also describes how the Federal Reserve will be able to bring back much of that money as the economy improves.

‘We are thinking carefully about these issues,’ Mr. Bernanke said in a speech in Atlanta last week. ‘Indeed, they have occupied a significant portion of recent [Federal Open Market Committee] meetings.’

Ideally the Fed will “reel in” the money in a manner that avoids inflation while not prompting another downturn. Reducing the supply of money generally means higher interest rates and a dampening of economic activity. You’ll see in the article that Federal Reserve officials are thinking a lot about this issue right now. You’ll also see some cautionary opinions from others who are skeptical that the Fed will be able to get the timing right. These critics worry that the Fed, for a variety of reasons, will be slow to turn off the money spigot and turn on the money vacuum. If they are slow, inflation can catch on and that is hard to stop or control.

So, when I’m asking about the risks of inflation due to all of this money printing, I agree with the inflation concern, but express my hope and confidence that Fed officials have thought this through and will reduce the money supply at just the right moment.