The Fed Can “Force” Expand The Money Supply

A little gem from Forbes: by John Tamney, entitled “The Fed is Not Printing Money, It’s Doing Something Much Worse.”

The article is full of little inconsistencies and obnoxious mixes of “big” words and poor word choices (using contractions after using a “fancy” word really detracts from your intended impression of thoughtful intelligence).  But this quote takes the cake:

The lesson here is that despite what is broadly presumed by economists and the punditry, the Fed can’t force money into the economy, nor can it increase “money supply.” Money supply is demand determined, and with the economy still relatively weak, there’s very little demand for the dollar credit that’s been expanded by Fed purchases of bank assets.

Fun Fact #1: there is always one entity that has an almost unlimited demand for money: the government.

Inconvenient Fact #1: the government has received all of the Fed’s monetary easing through its purchase of treasuries.

Conclusion: yes, the Fed can expand the money supply by purchasing government securities; the dollars then get distributed in the economy through entitlements and government spending.  This money ends up in… you guessed it!  Banks!  Who then use their now EXCESS reserves to invest (let’s ignore the nature of their investments).  Now banks have more money (and more assets and liabilities), and rates are low because the banks suffer little risk when lending due to their implicit guarantees (sometimes explicit).  The idea that there is no demand for credit is nonsense:  The Federal Reserve points out that there is more total outstanding credit in the US than at any point in history (seasonally adjusted).  Here is that data: Federal Reserve Historic Consumer Credit Data.

In January 2014, total outstanding consumer credit was $3.112 trillion.  In January of 2006, before the crash, total outstanding consumer credit was $2.371 trillion.  I did not analyze growth rates, but my guess is that growth has been slower post-recession, and is picking up pace.  Credit contraction began in July 2008 and continued through July 2010.  It was all uphill from there.  I also did not review the types of credit (revolving versus non-revolving), so I cannot say anything about the post-recession structure of consumer debt.  But I can say Tamney is wrong about the demand for money.

Fed easing may not be able to create real growth, but that is totally different from expansion of the monetary base, which is one thing the Fed can do.  I think the Forbes article needs to think through its oft illogical and contradictory positions.