How does money enter the economy?

Question

It seems to me that U.S. currency enters the economy as loans from the federal reserve to commercial banks, who in turn lend the money to others. That gets more money into the economy, but it's loaned and has to be paid back. How does the money end up staying in the economy?

Answer 1

First, congratutations, Bill, on recognizing what should be an obvious incongruity in ECON 101 text books everywhere. While loaning and re-loaning decribes one way of increasing the money supply, the astute student recognizes it has to start somewhere.

It starts with the Monetary Base a.k.a. M0. It can be determined in two ways:

1. (Total money supply) minus (all loans) = Monetary Base

2. Look it up on the Federal Reserve Balance Sheet http://www.federalreserve.gov/releases/h41/Current/

So how does the Monetary Base grow or shrink? This happens when the Fed buys and sells Treasury Notes on the open market with 'stroke-of-the-pen' money.

Here is an example:

Say the Fed decides the economy needs a $50B stimulus and the current effective deposit multiplier is 5. The Federal Open Market Committee (FOMC) then buy $10B in Treasury Notes from the public. This would end up in bank accounts which would be loaned and re-loaned until the $50B is reached.

The FOMC operations is very effective in adjusting the money supply quickly. For instance, during X-mas there is a higher demand for cash, so they will pump more cash in.

Similarly, if they recognize there is too much spending and not enough capacity, the Fed just 'sells' T-Notes which immediately pulls the excess money from the economy.

So what would happen if the U.S. stopped running a deficit and stopped creating T-Notes for the Fed to trade in? Not to worry. There is over $10T in T-notes and the Fed only owns about $770B. There is plenty of dept for the Fed to trade in for decades to come.

Answer 2

Your assumptions are basically correct.

In a simplified model you have four players:

households (consumers)
state (governement/state/counties/cities-towns = public households)
companies
Export/Import

There are markets and foods and services are traded/exchanged between the participants. Money is an "abstract" good and is traded against the goods and services.

The job of the Federal Reserve Bank is to keep the market supplied with a reasonable amount of money. The Fed has several targets: growth of the economical activity, (core) inflation of around 2 %, stable value versus other currencies, high employment.

The Fed loans money (better) capital into the banking sector which then is given to all participants as loans. With the interest rate ( and additional instruments) they set the interest rate in the economy and -depending on the actual sitaution - they try to influence the flow of money (and the flow of goods) in the economy. The Fed has meeting every 4 weeks, analyzes the actual situation and tries to come up with the "right" decision which interets rate they will set for the next weeks.

The banks have to pay back the amount they loaned to the Fed after the defined time but will take new loans from the Fed.

Examples: after the technology bubble in the stock market burst (2001) Mr.Greenspan started to reduce the interest rate to the banks, which then reduced the interest to the customer, in the end this stimulated the demand as money became cheaper and additional needs could be fullfilled.

After 9/11 was a high risk that the flow in the economy started to slow because consumers and companies were concerned about the situation. Greenspan was on a trip and went back the night of 9/12, he immedietaely gave a speech that the Fed will keep the markets supplied with money and all major reserve banks of the world reduced the interest rate the next day and "flooded" the market. (this was maybe the biggest achievment of his career)

Actual the Fed increases the interest rate as the leading indicators are all in the green (economical growth is OK, unemployment low at 4.5 %, the dollar is a litte to cheap for the export industry and core inflation a litle bid to high), the Fed tries to slow the demand and seems to be successful.

The nickname of Mr.Bernanke is : Helicopter Ben. Some years back he made a reamark which stated, that when the economical activity is slowing to fast there is always the chance to throw money out of an helicopter (means no interest paid) to keep the economy going.

Answer 3

Some how your guess is different than me Corporate borrowings from Commercial banks - goes to reinvestment or for reform and pouring the same money in economy.Any loans from the institution to any organization or individuals enter into the base of economy.Fundamentals of economy is Money ( currency).It's not going to end up cause it's an monetary UNIT of economy.

Answer 4

You misunderstand the money-creation process. New money is created down at the level of the retail bank. When one person deposits money into a bank, the bank can then lend out most of that deposit as a loan to a borrower. At that point money is created -- the original depositor still has all his money in his bank account, and now a borrower also has a sum of money.

The borrower starts paying that back as monthly payments from his income, but meanwhile he spends that borrowed money (say) buying a car. So the car dealer deposits that money into HIS bank -- and then most of it in turn can be loaned out, creating still more new money.

Answer 5

The paper money is valueless, the backing by gold has already been bumped off in view that 1971. the purely cost of paper money, or fiat forex is believe. remember on its ability to be exchanged for something of cost. to respond to your question, money enters the monetary gadget even as someone borrows money from the monetary company, both the time-honored monetary company (FED) or the huge banks (monetary company of united statesa., Citigroup, and so on). Say even as the authorities borrows one thousand million money to fund a particular project, it would want to bypass to the FED for a loan. It situation treasuries that the FED buys although the FED prints the money, or create new money to purchase those treasuries. on the different hand, even as someone or a business corporation is going to the monetary company to borrow money for say a house, a motor vehicle or to fund a corporation project, the monetary company can authorize the FED to print the money, for the monetary company to situation as loans. So money enters the monetary gadget even as authorities, organizations or persons borrow money. Conversely, all money will disappear even as everyone will pay decrease back their loans.

Answer 6

Money is only a means of exchange. These days it is mostly a computer entry on a piece of paper.

Answer 7

you almost have it, but the simple truth is, government's print it, or manufacture it, this increases the money supply and thus prosperity.

the economy not only produces wealth (products and services) but distribute wealth as well, in the form of spending the money the government prints.