What Determines the Rate at Which the Paper Money Supply is Increased?

Economics Economics Questions
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Hello everyone. I was wondering what determines the rate at which the paper money supply is increased? I believe I understand how fractional reserve banking increases the money supply, by giving ownership of the same money to mutiple individuals, through loans that are deposited in different banks. I think the current reserve requirement is 10%, so correct me if I’m wrong, but if someone desposits 100 dollars, the bank holds on to 10 dollars and can loan out 90 dollars. Afterwards 81 dollars of the 90 dollars can then be loaned out, et cetera. This process inflates the money supply, until the loans are paid back, thus deflation and hopefully in the process the loans were used in a productive way that grew the economy, thus making everyone potentially more wealthy.

A job of Federal Reserve, as I understand, is to buy and sell Treasury Bonds. This effects the money supply and alters interest rates. I’m assuming that when Federal Reserve buys too many bonds, this causes the business cycle. Also additional inflation is caused by the interest accumulated from the bonds, but I’m assuming this is paid with tax dollars, as the Treasury Bonds are bought and sold using the U.S Treasury’s account at the Federal Reserve, so this is really just a redistribution of wealth.

From my research I can not figure out how the actual paper money supply is increased. I’m assuming it does, as prices have historically been rising. An apple costs more now then it did in 1900, but in comparison to wages it may cost less, as apples can be collected with greater efficiency now. So what caused prices to go up, or in other words where did the money come from and what determines its rate? Sorry that my post reveals my lack of knowledge in economics, but I can’t help but be curious and I just can’t find the answer anywhere online. Thank you in advance for your responses.

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  1. The idea that hopefully the loans were used in a productive way that improved the economy is a bit of wishful thinking.

The idea is simple. At 100% reserve, no money is in the bank unless somebody put it there, meaning he didn’t spend it, meaning he had underconsumed, meaning he had made more money [=produced stuff] than he spent [=consumed stuff]. Thus there is a surplus of unused stuff out there. Which means it can be used to make machinery etc to increase production. In other words, when a businessman borrows the money, there are actually resources out there for him to buy with his money.

But if the money is created out of nowhere, as in fractional reserve banking, then it is going to be looking for resources that aren’t there. Which is going to spell bad news, usually price inflation. and malinvestment and ultimately, if done on alarge enough scale, a recession.

  1. What is does do is inflate the money supply, which right there is the answer to your q. You don’t need the paper money supply to go up to have price inflation. After all, the stores accept checks and digital money, too. So there will be more money running after the same quantity of resources, meaning higher prices.

  2. The business cycle is not caused by the Fed buying too many bonds per se. The key is how do they pay for those bonds. And they pay for new bonds with new money, meaning they “print” new digital money to buy new bonds. This done by the Fed simply opening up its computer to its own account, seeing that it says they have a balance of, say $10 trillion, erasing the 10 and inserting a 20. Voila. They now have an extra 10 trillion of digital money to spend, that did not exist before. This is what causes, ultimately, price inflation. Again, more money chasing the same reosurces.

  3. Interest accumulated by the bonds does not cause inflation if no one prints new money to pay the interest. Then that money has to come from taxes, as you say. Of course, if the Treasury borrows from the Fed once again to pay off the interest, then it will mean the Fed printed new money once again, so it will cause price inflation again.

  4. The paper money supply is increased when the Treasury actually prints it physically on their printing presses. They are not allowed to do so with out limit. I don’t know much about this part. Paper money makes up about 10% of the money actually spent in the US, the other 90% being digital money and checks.

  5. The money came from the Fed creating more and more over the years, and of course from fractional reserve banking. What determines the rate of inflation is a deep topic. I don’t think anyone has come up with a formula, because of various difficulties. First, not all things go up at the same rate at the same time. Second, people’s expectations of higher prices influence to some extent the rate of the rise. Third, prices are influenced by supply and demand for the actual individual products, which is always changing, The best result anyone has is that it is not linear, meaning double the money supply does not mean double the prices, at least in the short run. I think [not sure] that in the long run the linear relation is close to being accurate, the long run being, say, twenty years later.

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Thank you so much for your answer Smiling Dave. In regards to 100% reserves, would loans then only come from saving accounts, as these funds are not in the immediate possesion of their owner, while the money in checking accounts would sit idly at the banks? Would this raise interest rates to the point of stifling economic growth? Maybe I misunderstand fractional reserve banking, but I’m under the impression that someone has to make a desposit at a bank and then part on the money is reserved, while another part can be used to give people loans. With 100% reserve banking does that mean that all the money has to be reserved and none can be given for loans? Sorry, most likely I just don’t understand the process correctly.

With fractional reserve banking is the money supply, in theory, only inflated temporarily, as the loans are eventually paid back? So the boom would be inflation, without adequate deflation because the investments were made without proper consumer savings, so the loans weren’t paid back, but for prices to, in theory, permanently rise would an expansion of paper money be necessary?

Why does the Federal Reserve print money digitaly, when the Treasury can just print more paper money and deposit it at its Federal Reserve account, which the Federal Reserve uses for the transactions of bonds? Even if the Federal Reserve does create money, wouldn’t it be in to the Treasury’s account, thus it is the Treasury’s ability to back the digital desposits with paper money and the Treasury’s request for funds that creates the money. Your definitely right, I think, that the Federal Reserve is in the middle of the money creation, otherwise prices would only deflate but is the permanent injection of money from interest on the bonds? From my understanding the Federal Reserve creates more money to buy bonds from the Treasury, which it then sells to banks, but it first has to sell the bonds to banks before it buys them back, I think atleast. So does the inflation from the purchase of bonds, require a prior deflation by the sale of the bonds and only the interest accumulated from bonds create a permanent inflation?

Great point that the supply of money does not have to strictly correlate with the rate of inflation, but is there any measure for the rate at which the Treasury prints money, or the Federal Reserve creates digital money? Does this it have anything to do with GDP and in effect keeping the overall level of prosperity even? But what would be the purpose of that? Thank you again so much for helping me with my questions.

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  1. With 100% reserves, it would all depend on your arrangement with the bank when you deposit your money. There would be two possibilities. You could give it to them to store for you in their safe, accesible to you on demand. In this case they would probably charge you a small fee and of course pay you no interest. Or you could lend it to them, get some interest payments, and not be able to withdraw the principal until the date the loan was to be repaid.

As for stifling economic growth, why do you think high interest rates stifle economic growth?

  1. The answer to your second paragraph is yes and yes, though I didn’t get your description of the business cycle.

  2. Third paragraph. It’s done because at the time when the Fed was created the thought of a govt printing all the money it wants with no restraints was unacceptable to most people. So to obscure matters and make it seem like the govt had some restraints, they created this system where only the Fed can do it, a supposedly private sector body.

The way it works is this. The Fed has no printing press to make paper money, and the Treasury is not allowed to print nearly enough money to satiate the govt cravng for spending money. But the Fed is allowed to write checks as much as it wants, to change the numbers in their books freely, to give itself as much digital cash as it wants. So the way it works is this. All new money [besides the insignificant amount that is actually printed paper money] comes into existence by the Fed giving itself new non paper money. It does this by changing what they have in their books and computers. The govt then borrows that money, or the Fed lends it to the big banks. In either case, that’s how it comes into existence. Prices rise when the govt and/or the banks start using that money, to spend or to lend to someone who will spend it. Even if all this was done interest free, new money has been created. In theory, if the govt and/or the banks would repay the loan in full and it would then just sit unspent in the Fed’s computer, then yes, the money supply would shrink back. But this never happens. The amount of money leaving the Fed is more than what comes in.

Lately the Fed has started buying bonds directly from the Treasury. In the past, this was considered a method too blatant and obvious that that the govt was using the Fed as a printing press, so the banks were used as middlemen to obscure things. But bottom line, why else would the Fed create new money if not to give to the govt? BTW, there is a free video available that explains the whole thing, forgot what its called.

There is a certain type of ignorance that thinks our troubles are because “new money is debt, and the interest payment increase our indebtedness, so we are always getting into greater debt we can never escape bla bla”. Their lack of understanding is matched only by the shrillnes of their hysteria. They think that if the Fed was closed down, and new money was created by the Treasury printing it and spending it, with no new debts and no interest to anyone, then all would be well. As if the law of supply and demand does not apply to money.

The Treasury does not have to back anything with paper money. 90% of trade in the US is done without paper money.

  1. There are various measures of the money supply that give a clue as what the secretive Fed is up to. See Wikpedia on money supply.

GDP is a great fiction, very usefull for the govt. According to the way GDP is measured, if the govt spends a trillion dollars on a cocaine party for Obama, GDP tells us the economy has “grown” by a trillion dollars.

  1. Bottom line, the govt constantly wants money, and lots of it. They tax as much as they think they can get away with, and digitally print the rest through their stooge, the Fed. This creates price inflation, which impoverishes the country, and in the past everyone understood this. So secretivesness, and purposefull confusion, and mass brainwashing by teaching only Keynesian economics, and other tricks were needed to fool everyone. Nowadays the public has been so dumbed down that it’s enough to say they are printing money to “fight deflation”, or to raise GDP, or to create jobs, or to keep the overall level of prosperity, and everyone is satisfied.

  2. Have you read Hazlitt’s Economics in One Lesson? And Rothbard’s What has Govt Done to Our Money? Both are free, short, readable, available on this site, and enlightening. From your q’s I think you might gain from them. And try to find that video about the Fed. I think it’s from this site, or from FEE.

Oh, forgot. You’re welcome.

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My assumption is that if loans are only given using saving accounts, there would be a lot less money to loan out, thus interest rates would be much higher and new businesses would have a more difficult time forming wihout access to relatively inexpensive loans and existing businesses will have a more difficult time expanding. Granted there would be no malinvestments, but can’t checking accounts be viewed as a surplus also?

Sorry, I reread my description of the business cycle and I’m admitedly not the right person to describe this process. I’ll give it another try though and please correct me if I’m wrong. Malinvestments were made because consumers did not save enough in proportion to the investments made, dictated by interest rates and therefore the loans could not be paid back because the businesses didn’t make enough money and ineffect the currency could not deflate through the repayment of loans, resources were misallocated and in effect the economy experiences a recession.

Wow, so the real effect the Federal Reserve makes is in the form of loans, not bonds? I always thought the Federal Reserve was just a lender of last resort, to repump up a bubble but the Fed actually gives out loans on a regular basis and doesn’t expect repayment? So inflation, through the Fed, is primarily just outstanding loans granted by the Fed, which overtime they choose to forget about? I believe you because the National Debt must have come from a very compliant lender (although another large lender I’ve heard is China though), and the level of inflation can not just be from interest accumulated and even if it were the additional money couldn’t just come from taxes inorder to have a lasting inflationary effect, but is it written anywhere that the Federal Reserve has the power to alter its books in anyway it feels appropriate? I’m going to have to read the Federal Reserve Act and see if I can find any correlating information.

Since 90% of trade in the U.S is performed without paper money, would it be appropriate to say, that if I can find the rate at which the Treasury prints money, that the Federal Reserve has the potential to create around $9 out of every dollar the Treasury prints?

Thank you so much for your book recommendation. I’ll start reading them now and I’ll look for the video. Could I ask what does the acronym “FEE” stand for? Thanks again, you’ve been so helpful.

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The Federal Reserve System (“Fed”) is a public-private partnership - i.e. a cartel - in money and banking. One of the main reasons the Fed was created was to protect member banks from the threat of bank runs. Member banks wanted this protection so that they could continue to engage in fractional-reserve banking. Indeed, they not only wanted to continue to engage in it, but they also wanted to expand it. Why did they want to do that? Because fractional-reserve banking promised to make them piles and piles of money, as long as they could keep it going.

For these member banks, the Fed serves as a “lender of last resort”. In the old days, before the Fed cartel existed, banks could run short of their loan obligations and be unable to borrow more money. Thus they would face bank runs and go bankrupt. The Fed is legally obligated to lend money to member banks when they need it. It lends it out at an interest rate called the “discount rate”. Additionally, member banks can trade reserves that are held at the Fed. All member banks must keep a certain amount of such reserves there - this is called the “reserve requirement”. The interest rate at which member banks lend reserves - the “federal funds rate” - isn’t set by the Fed directly. This is where Treasury Notes come into play.

Since these banks didn’t want any competitors, they proposed government legislation to create a cartel for them. Of course, the government wanted in on the action, too. So another aspect of the Fed is that it’s also the lender of last resort for the government. Anytime the government wants more money than it currently has, it prints up some bonds - Treasury Notes - which it then sells to willing buyers. One of these willing buyers can be the Fed. Unlike any other buyer, however, the Fed can use newly-created dollars to buy the Treasuy Notes. As you can imagine, this would increase the supply of money in circulation.

The amount of money in circulation influences the federal funds rate. If the amount increases, the federal funds rate will decrease, because it’s relatively easier to loan money. Likewise, if the amount decreases, the federal funds rate will decrease, because it’s relatively more difficult to loan money. At any given time, the Fed has a target for the federal funds rate. It then uses what are called “open market operations” to keep the actual rate close to the target. Open market operations consist of the Fed buying or selling assets (such as Treasury Notes) to change the amount of money in circulation.

Unless the Fed directly monetizes a lot of government debt, it won’t directly have a large effect on the money supply. What will still have a large effect on it is the fractional-reserve banking being conducted under it. The Fed serves as the monopoly control that allows the fractional-reserve banking to continue and expand. However, this unwittingly results in the so-called “business cycle”, because the amount of financial capital is essentially decoupled from the amount of “real” (i.e. non-financial) capital, and thus also from real consumer preferences.

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Thank you so much for your very clearly written response Autolykos. I think because of it I understand the way the Federal Reserve works better now. So the Federal Reserve creates money to buy the Treasury’s bonds and then sells them to banks, which in turn inflates the money supply. It also gives loans to the banks and the government when they need them. These loans in effect monetize the bank’s and the government’s debt. In an idealistic society, where everyone pays back there debts, would the money supply shrink back to its original level, as all bonds would be bought back and loans would be repaid? It appears that currently the reserve requirement is at a level that allows the business cycle to from, but is there a level under 100% that might prevent business cycles and make it so banks would not need Federal Reserve loans? Also are there any written limitations, that define “lender of last resort?” Thanks again for your response Autolykos.

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You’re welcome!

Well, the Fed can buy government bonds. That doesn’t mean it always or necessarily will buy them. Even when it does buy them, it doesn’t have to buy them with newly created money - but it can do so. However, when it does buy bonds with newly created money, it’s certainly inflating the money supply.

They can, but again the Fed isn’t strictly required to use newly created money to make loans to member banks or to the government. If the Fed currently owns non-money assets, it can sell some/all of those assets in order to obtain the money for making the loans.

No, because the money would go back to the Fed - it’s not necessarily destroyed upon being paid back. Furthermore, the money that member banks borrow from the Fed could be loaned out in turn by those banks, which inflates the money supply even more because of fractional-reserve banking.

Probably not, IMO. Fractional-reserve banking decouples financial capital from physical capital and consumer preferences. It makes it easier for people to get loans than it otherwise would be, and thus makes business ventures look more affordable to people than they otherwise would be. A recession will occur after the rate of money creation decreases. This can happen when one or more fractional-reserve banks go bankrupt, when the Fed raises the reserve requirement for member banks, or even when the Fed raises its discount rate or sets a higher target for the federal funds rate. In any event, the business cycle is exacerbated by centralized political control/regulation of money and banking (e.g. the Fed).

I don’t know off the top of my head, but I could try to look into that for you. A good start, if you want to look into it yourself, is the Wikipedia page on the Fed.

Again, you’re welcome!

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Elise, welcome!

The Fed creates money to buy Treasury bonds (i.e. the Fed lends money to the govt), which money is then deposited (or spent and deposited) into banks. The banks then use these deposits as “reserves” on top of which they can create 10x the amount of money originally created by the Fed. It is this last part that “creates” most of the new money – not the Fed.

Buying Treasury bonds is just another name for “giving loans to the government”. As for the banks, yes, any member of the bank cartel has access to the Fed’s so called “discount window” from which they can borrow (newly created money) at the overnight Fed interest rate if they need it to satisfy the reserve requirements (i.e. when their reserves get below 10% of their loans). Banks also borrow/lend from/to each other in the overnight market. The ones with “excess reserves” lend to the ones in need of reserves to satisfy the reserve requirement.

Yes, most of the money people hold as cash in their pockets and in their bank accounts has been lent/borrowed into existence. Every new $ created today is created as someone’s loan. If all debts are repaid then the money supply would shrink to almost zero, or to the amount of money that existed before the century-long debt (money supply) expansion. This is how whole societies have been blackmailed by the cartel to support (and vote for) perpetuating the money creation/expansion, or else…

Raising the reserve requirement (from 10%) is equivalent to cutting the money supply, or at least slowing down its growth. Booms and busts (i.e. malinvestments) will occur as long as fractional reserve banking (creating money out of thin air) exists (with or without a central bank, i.e. a lender of last resort).

Yes, they are called laws. Only the Fed and the cartel member banks can create $'s on their computers. You or I can’t.

After reading Rothbard’s “What Has The Government Done To Our Money?” and/or “The Case Against The Fed”, I highly recommend reading Griffin’s “The Creature From Jekyll Island” for an excellent exposition of the motives behind forming central banks through history, and especially the Fed. Here’s a video of his lecture on the book: