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The Federal Reserve Cut is Irrelevant

This article was written by in Economy. 15 comments.

The Federal Reserve is expected to drop the federal funds rate to 0.5% today, the lowest it has ever been. When the Fed drops rates, its intent is to increase lending between banks. This drop, however, will likely have no effect on the bank’s lending practices.

This rate is just a target, and it doesn’t dictate the exact rates banks offer each other. In fact, banks have been recently offering each other rates much closer to zero, and interbank lending is still moving slowly.

When the Fed has nowhere else to go, they begin “printing money.” I hear this term in the media, and the most obvious assumption is that “printing money” means that the Bureau of Engraving and Printing speeds up their presses and pumps out more $1, $5, $10, $20 and $100 bills. At least, that’s what I thought until recently. That’s not quite how it works.

“Printing money” is what the government calls it when they raise money by buying back short-term debt from the public, call them bonds or Treasury bills. Companies and individuals can buy money from the government, money that doesn’t really “exist” until it is purchased.

Published or updated December 16, 2008. If you enjoyed this article, subscribe to the RSS feed or receive daily emails. Follow @ConsumerismComm on Twitter and visit our Facebook page for more updates.

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About the author

Luke Landes is the founder of Consumerism Commentary. He has been blogging and writing for the internet since 1995 and has been building online communities since 1991. Find out more about Luke Landes and follow him on Twitter. View all articles by .

{ 15 comments… read them below or add one }

avatar Adam

Unfortunately, the “public” that we are selling this short-term debt to is mostly foreign countries. I’m not sure if I would rather print new money or have China own all of our debt. That seems to be quite a bit of control if you ask me!

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avatar Paul

I’m not sure I understand this last paragraph about printing money. If the government is selling debt, the American consumer is exchanging dollars for that debt instrument, I don’t see where money is created in this scenario. Furthermore, wouldn’t this action be decreasing the money supply in the country by shifting it temporarily to the government, not the other way around as ‘printing money’ implies?

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avatar Rassah

I’m thinking “printing money” in this case means the government is actually buying back it’s bonds and t-bills, thus releasing the money supply that used to be tied up in securities, and in this case it may actually be “printing” new money, even if only via electronic transactions. I may be wrong though. Been a while…

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avatar Goalhunter

The federal reserve drops interest rates by increasing the money supply (“printing money”). Banks lend each other money “overnight” to balance their short-term requirements. Think of that money as equal to cash in this case. If banks have lots of cash then not many need to borrow and rates are low. If cash is tight then relatively more banks will need to borrow and rates go up.

Also if banks have lots of cash they can lend that money out to customers so rates go down in the “real world” too, although we don’t get the same same rate as the inter-bank rates.

How do they print money? They buy back loans, or T-bills, on the open market. In that way they inject cash into the system. To remove money they sell T-bills.

No modern government “prints” money anymore. Now the banks create most of the money in the economy through loans. Which is why the credit-crunch hurts so much … all the money dryed up. This is not cash money, so it’s not the same kind of money that the federal reserve adjusts. This is money on the books of banks.

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avatar Mr. ToughMoneyLove

The government “printing money” can mean a lot of different things but at the end of the day, it is actions that are taken by the Fed and government to increase the supply of money available for spending by either the public or the government. What is happening now that perhaps is the most direct form of “printing money” is that the Fed is monetizing government debt. Instead of Treasuries or other debt obligations being sold by the government to banks or the open market, the Fed is purchasing them. This leaves existing money in the open market plus provides additional money to the government to spend on its own projects. Voila – the money supply is increased and inflationary pressures develop. In my opinion, that is the kind of “printing money” that is the most damaging.

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avatar Goalhunter

I don’t see the problem. It’s a market activity. The bank is “paying back” debt by buying it’s own debt on the open market. It’s like a share buyback.

The Fed doesn’t have unlimited leverage for these kinds of activities because it costs a lot, but there are others it can use too. For example, if banks can’t borrow from other banks then they can always go to the Fed. If the Fed sets a very low interest rate then other banks have to follow suit from an interbank view anyway, but that doesn’t change the money supply. Another way is that they can change the rules for banks to allow them to have lower cash reserves, and then the banks can .. viola .. create new money on their own.

I think those other levers would be worse.

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avatar Bill M

cheaper finance charges, means more borrowing, means more leverage, means live more than your means, and screw all the people that did it right, the savers, etc.

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avatar Goalhunter

What about the businesses? They get screwed by high borrowing costs. They go under through no fault of their own (maybe they were responsible but now they can’t finance their business operations from any source), their employees lose their jobs, they don’t have any money to spend, then it ripples through the economy.

Consumer credit ought to be illegal, but the rest of the economy runs on credit too.

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avatar SomeGuy

As everyone probably knows, the fed actually dropped the rate to 0-0.25%. And it has already had an effect. Rates under 5% can now be had on 30-year fixed-rate mortgages. Of course the stock market went up, too. That is much less noteworthy and likely temporary.

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avatar UH2L

I believe that more “printing of money” devalues the dollar. That’s why investing in international stock funds and inflation protected securities is a good idea, (in my opinion).

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avatar Nicole

I took a tour of the the Bureau of Engraving and Printing in Fort Worth this year (amazing and totally worth while if you ever get the chance). They definitely indicated that there are no additional notes printed since they get an order once a year and that only replaces notes that have gone out of circulation. When we hear that the government is “printing more money” it’s more like an additional number gets added to the national ledger – it still causes the dollar to devalue, but there are no more notes in circulation than at other times.

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avatar Chris

It just irritates me that none of the cuts seem to be passed along to the consumers. We bail out the banks, the fed cuts their rates and we still don’ t get lower rates when we go to make big purchases. I wish they would print more money and send it directly to me instead of Ford or GM.

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avatar Goalhunter

The government does not “Print Money.” They take market actions, i.e., buy and sell with cash to influence the money supply.

The ones who print money are the banks because they are allowed to lend more than they have.

You could print money too between you and your friends just by making loans to each other, as long as you all agree you are good for it. You lend Jimmy $100 and he give you an IOU for $100. Wham-o, you just created $100. Jimmy can spend the $100 because it’s cash, and you can spend the hundred because your friends will always be willing to spot you cash on the strength of the IOU.from Jimmy that you hold. You can probably sell Jimmy’s IOU to Lucy saying “Hey I need $100 this weekend, have this IOU and Jimmy will just pay you back instead of me.” Or you just write your own IOU to Lucy, say if you only need $10. After awhile there might be a few IOUS is circulation.

That $100 IOU from Jimmy and the $10 from you are only good between you and your friends, but when banks do it it’s good everywhere.

The credit crunch comes when Lucy asks for her $10 cash. No problem, you say, I’ll just get paid from Jimmy and pay you back. Only Jimmy doesn’t have the cash. Jimmy’s bankrupt and he’s not your friend anymore. No problem, I’ll just write another IOU to Sally or Bill for the $10 to pay back Lucy, except Sally or Bill don’t have extra cash to lend you either. So now you’re bankrupt too, and Lucy hates you. But Lucy’s probably in the same boat and owes someone else money. Everyone goeas bunkrupt because there is not enough cash money amongst all of you to cover all the IOUs.

That’s what happens when the credit system fails.

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avatar Emily

When I heard this on the news, I felt very conflicted. The Fed has been using cutting interest rates as their main tool to fix the economy, but things have only gotten worse (not because of their actions, but their actions don’t seem to have helped at all). I heard Obama say on NPR that because the Fed is running out of cards to play, the onus will now be on the other branches of government to step in and make some moves. I just wonder what it will take for things to improve. It’s frustrating that even the Fed can’t seem to help…it makes me feel completely helpless. I guess the best thing we can all do right now is to live within our means.

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avatar vilkri

Mr. ToughMoneyLove says it correctly. It depends on what we mean by “money” when we want to understand what “printing money” means. In the end money is at best a piece of paper. We all believe that the print on the paper denotes its value. But these days there is a lot more money that exists only in electronic form. When the Fed buys Treasury bills and bonds it creates the electronic kind of money. The Fed is not giving dollar bills to the Treasury department.

The current financial problems are not really rooted on how much money is available – there is plenty. The problem is that the velocity of money has slowed down tremendously. Everybody starting with the banks is sitting on cash. Before the crisis money was sent from one account to the next in ever shorter intervals. Now money is just stuck in one account. So, the fed has to make up for slower moving money by “printing” more and more of it. Eventually this will lead to inflation, but that is a heck of a lot better than deflation which is a real danger right now.

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