I understand how the fed inflates the currency, but I do not see where the governments gets the inflated supply. Help?
"The plans differ; the planners are all alike"
-Bastiat
They sell bonds to the Fed to be paid for in inflated currency...commonly called monetizing debt.
How much revenue does the government get from this?
I'm new to this so go easy on me. So in time the government will have to pay back on the bond with interest, thus digging ourselves into a deeper hole?
ChaseCola: How much revenue does the government get from this?
Last year the Fed earned $42B - mostly on income from its holdings of US bonds, and it paid its profit (after expenses) of $35B to the US treasury.You can find its statement of income and expenses here: http://www.federalreserve.gov/boarddocs/rptcongress/annual07/pdf/fro.pdfThe Fed makes a profit because it earns income on most of its assets (e.g. US bonds) but pays no interest on its liabilities - viz FRNs and deposits by private banks.This works out very nicely for the USG (US Govt). It prints bonds to cover its deficits. Then it is assured of a market for those bonds, namely the Fed. Then the interest which it pays on those bonds is returned to it - by the Fed.In recent years the USG hasn't needed the Fed so much because Asian central banks (notably Japan & China) have bought so large a share of US treasuries.That's where the Fed comes in handy again. Turning debt into money is always inflationary, as AC points out. So the USG will get to pay its Asian bondholders in depreciated currency. Imagine what the $US will be worth in 30 years, when its bonds fall due!So the indirect benefits of the Fed to the USG outweigh the direct benefits.
LanceH:This works out very nicely for the USG (US Govt). It prints bonds to cover its deficits. Then it is assured of a market for those bonds, namely the Fed. Then the interest which it pays on those bonds is returned to it - by the Fed.In recent years the USG hasn't needed the Fed so much because Asian central banks (notably Japan & China) have bought so large a share of US treasuries.
IOW, the USG issues checks in excess of several hundred billion dollars of its cash on hand each year. So, it issues bonds in that amount to cover the deficit. Central banks, including the Fed, and private dealers purchase the bonds and the USG's account with the Fed is credited accordingly. The unsold issues, and there are lots of them actually, get rolled over into subsequent auctions. In the meantime, the Fed keeps honoring the USG's checks presented for payment to it and doesn't charge the USG any interest or overdraft charges.
So, to my untrained eye, it appears the inflationary part is the Fed creating money out of thin air to pay USG checks for that part of the annual deficit not covered by proceeds from the bond auctions. Now, what I've also read is that central banks will just run money off the printing presses to purchase bonds but I'm not sure about that.
Any clarification/correction of the above appreciated.
Also, the Fed's role as a lender of last resort means that when there are bank runs, they print up the lacking amount of money and directly give it to the banks, thus inflating the currency that way.
Of course, most of the inflation that occurs is non-government sponsored, and done by commercial banks that lend out on a fractional reserve basis. If I remember correctly, central bank directly printed money (as opposed to obfuscated lending out of demand deposits) is less significant. Btw, isn't what the Fed does called Open Market Operations?
If you try to trick the market, it will get its revenge.
Solreyus
Byzantine:IOW, the USG issues checks in excess of several hundred billion dollars of its cash on hand each year. So, it issues bonds in that amount to cover the deficit. Central banks, including the Fed, and private dealers purchase the bonds and the USG's account with the Fed is credited accordingly. The unsold issues, and there are lots of them actually, get rolled over into subsequent auctions. In the meantime, the Fed keeps honoring the USG's checks presented for payment to it and doesn't charge the USG any interest or overdraft charges.
AFAIK The Treasury tries to keep its balance at the Fed fairly steady - at about $6 bn I think - so that it doesn't interfere with the fed funds market. I'm not aware of any time in recent years that it's been overdrawn.
Byzantine:So, to my untrained eye, it appears the inflationary part is the Fed creating money out of thin air to pay USG checks for that part of the annual deficit not covered by proceeds from the bond auctions. Now, what I've also read is that central banks will just run money off the printing presses to purchase bonds but I'm not sure about that.
Certainly the Fed buys & sells treasuries all the time in open market operations, and it is only the net increase each year that matters.The Fed will print currency, or rather pay Treasury to print it, only to meet an extra demand for currency in circulation, or to replace old notes. In recent years, the volume of currency in circulation has been steadily shrinking. Overseas the depreciating greenback is not as popular as it used to be, while at home it has lost ground to e-transactions and credit cards.
Fred Furash:Also, the Fed's role as a lender of last resort means that when there are bank runs, they print up the lacking amount of money and directly give it to the banks, thus inflating the currency that way.
The Fed would probably arrange an emergency loan through the new Term Auction Facility. The Fed accepts some of the bank's illiquid assets as collateral, and sells the same value of treasuries so that its net liabilities remain constant. That's not inflationary - at least in its effect on the monetary base.
The bank can then redeem its extra reserves for currency on demand.
The Fed should do that only if it considers the bank solvent (i.e. able to raise capital or sell assets to stay afloat). Otherwise it will try to arrange a quick sale to the highest bidder (as with Bear Stearns), or failing that tell the bank to get lost and leave FDIC to clean up the mess.
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