Start the Presses?

What it means for the Fed to start “printing money.’

Foreign governments are criticizing the recent announcement that the Federal Reserve would be injecting an additional $600 billion into the U.S. economy. In the following column, first published in the November 2008, Jacob Leibenluft explained what it means to “print money” in the electronic age.

With the Federal Reserve struggling to find new ways to stimulate the economy, some financial commentators—like the Washington Post’s Sebastian Mallaby and the Economist—have mentioned the possibility that the Fed might start “printing money.”

Does that mean the government will just start producing more dollar bills?

Not exactly. The Federal Reserve usually decides a couple of months ahead of the new fiscal year how much cash it needs to print for the next 12 months—much of it simply to retire old bills from circulation. Once it makes that estimate, it sends its annual order over to the Bureau of Engraving and Printing. (Here’s a description of the Fed’s order for 2008.) Those bills enter circulation through a pretty simple process. Banks are required to keep money in a reserve account with the Fed. When people cash checks or take money from the ATM, those banks replenish their cash supply by getting currency from a Federal Reserve branch, with the amount debited electronically from the bank’s reserves. As the New York Fed points out, the amount of currency in circulation can vary from day to day and season to season: More people want cash during the holidays, for example, or on the weekends.

Although the stock of currency in circulation has increased by about $43 billion since last year, there is no immediate evidence that the bureau is working its printing presses overtime or has any plans to do so. By the Explainer’s calculations, the BEP printed $14.1 billion worth of bills last month—less than it printed in either October 2006 or October 2007, despite the Fed’s recent efforts to stimulate the economy.

So what do economic commentators mean when they say the Fed might choose to “print money”? After all, even Fed Chairman Ben Bernanke has used similar language before, explaining in a 2002 speech—when he was a governor on the Federal Reserve Board—that “the U.S. government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at essentially no cost.” (Bernanke also noted that John Maynard Keynes once “semi-seriously proposed, as an anti-deflationary measure, that the government fill bottles with currency and bury them in mine shafts to be dug up by the public.”)

In practice, the term “printing money” is often used as shorthand for what economists call quantitative easing. Typically, major monetary-policy decisions by the Fed are made by setting a target for the federal funds rate—the interest rate at which banks lend to other banks—and then buying or selling government securities to achieve that goal. But as the targeted federal funds rate nears zero—it currently stands at 1 percent—the Fed may be forced to look for other options to fight off possible deflation. (Japan has found itself facing similar problems in recent years.) Quantitative easing is an attempt to increase the money supply by buying more and more assets from banks without regard to an interest-rate target. The Fed doesn’t need to print more currency to do that; it can simply happen electronically, as the banks are credited with more money in the accounts they keep with the Federal Reserve. The Fed can do this as much as it wants, but it could face two potential problems. For one, it’s possible that those reserve accounts will keep growing without stimulating any economic activity. Alternatively, the Fed could increase the money supply by too much, resulting in inflation.

Got a question about today’s news? Ask the Explainer.

Explainer thanks Claudia Dickens of the Bureau of Engraving and Printing, James Hamilton of U.C.-San Diego, and Richard Sylla of New York University.