Edit: OK, they can also make negative interest loans but that's both rediculusly rare and creates tiny amounts of currency relative to the amount loaned.

PS: Consider what happens when they buy a US treasury note it's worth say 100million now while they hold the bond there is extra 100 million floating around. However if they sell it in a year they just removed 102 million from circulation net result 2 million is forever gone.

- QE is about creating new money. The buying of loans is merely a way to distribute it; instead of just giving the money away, the central banks buys an asset (any asset would do) so nobody gets an unfair advantage through distributing the new money.

- all loans can be repaid. At the end, people would just own dollar bills which in turn don't depend on anything else for their value.

- a lot of the confusion around money comes from confusing different sorts of money as being the same thing. We commonly use two sorts of money: Base money (e.g. dollar bills) that depend on nothing. This form of money can only be (legally) created and destroyed by the central bank. The second form of money is Bank money which is a loan of Base money. THis form of money can be created or destroyed by many individuals and banks.

- As an example of Base money vs Bank money, when I pay $100 into a bank, I have really loaned the money to the bank - it owes me $100. Yet I can "spend" this loan with my bank card and by goods from a shop, now the shop is owed $100 by the bank. The loan is a form of money; I really did have some Bank money. But the original $100 bills were sat in the bank vault, and they are definitely still (Base) money.

As I said QE is about creating money in the short term. However, there are vary good reasons why the FED buys bonds vs say Gold. A major goal is to reduce the interest rate on long term loans. But, this means that the asset they acquire is generally worth more nominal dollars in the future. So when sold or simply paid back the money supply shrinks.

That's not to say the FED can't purchase more assets to make up for the lost money. But, the temperary nature of QE is seen as a benifit that helps avoid inflation.

Yes, I'm aware that it is promised to be temporary. I'm also aware of how the markets freaked out not long ago when Bernanke hinted that the Fed might consider exiting QE2 ahead of schedule if the economy continued to recover faster than expected. (This very innocuous statement was quickly retracted.)

It is therefore clear that the markets have no expectation that there will be an exit from the policy any time soon. And people that I've talked to on Wall St do not see a viable way to do it short of currency collapse.

No, the 2 millions are paid out as dividends to the government.

The idea that inflation happens because of "printing money" is a fiction. And a harmful one, IMHO, because it gets used as above as an argument to support some pretty ridiculous policies.

The banking system on its own could not account for consistently rising prices for the past hundred (or however many) years.

The thing is, though, that banks hand out loans independently of how much reserves they have. Only afterwards do they check whether they need more reserves, and obtain them if necessary. This is even reflected in the internal organization of banks: Loans and reserves are in different departments.

The central bank creates new reserves as a reaction to increased demand by banks as part of its normal operation. It is not a political decision to do so. The political decision is to set the target interest rate (Fed funds rate). The money supply fluctuates to accommodate the demand of borrowers given that interest rate. Because of that, private banks can and do account for the monetary expansion that goes hand in hand with rising prices.

However, it is probably more accurate to say that banks accommodate rising prices, i.e. the causality goes from rising prices to an increase of money (that is, causality goes from right to left in MV = PQ).

Most importantly, firms use more credit to cover their operating expenses as prices rise, and home owners take out larger mortgages as house prices rise, etc. This increase in the loan volume as a reaction to price increases is what drives the growth in the money supply.

All this about reserves is of course very far away from the fairy-tale stories of banks taking in deposits and loaning them out. Unfortunately, banking tends to be pretty opaque, and you really need to dig into this stuff to understand it. People like the MMT bloggers have popularized a proper understanding though, so it's not as difficult as it used to be (the MMT bloggers like Bill Mitchell and Randall Wray tend to have blind spots in other areas, but they have studied the monetary system pretty thoroughly and know what they're writing about in that regard).

Finally, if the fed didn't exist do you think the free market would allow banks to have such low reserve requirements? I'm guessing that the fear of bank runs and bankruptcy would significantly limit the amount they loaned (created).

Inflation is a matter of supply and demand. As long as there is excess supply, one can buy the supply with newly created money without raising prices. That's supply and demand 101.

The only tricky part is figuring out how much money can be safely printed. Central planning tends to be bad at this (which is why so-called military Keynesianism is a bad idea from an economics point of view, even if you don't care about pacifism).

The trick is to figure out a decentralized and automatic approach. That is, an approach that automatically increases the amount of money creation when there's slack in the economy, and automatically scales back when the economy is operating at full capacity.

I don't understand how this works in the case of, say, quantitative easing, which released tons of new cash into the economy, while nothing else had fundamentally changed with regard to supply in the economy. By your definition, wouldn't that create rampant inflation?

Or, are you saying that much of that money ended up in the equities market vs. "in the economy" as fresh demand, which allowed supply/demand equlibrium to remain virtually unchanged?

You can quibble on what "causing inflation is", but:

- Money is a lien on production of goods and services, e.g., "real wealth" (as opposed to "financial wealth").

- Increasing the amount of money in circulation means that each unit can demand a smaller portion of those goods and services.

- Whether or not inflation is experienced depends on whether or not the money supply, or real wealth, are increasing faster. However we can absolutely say that increasing the money supply will increase inflation over not increasing it.

- Modulo various other factors: is money being destroyed elsewhere in the system (bonfires of Franklins, asset bubble crash, loan defaults, negative real reaturn on business investment)? In that case, net inflation may still be negative, but once again producing more money increases the relative rate of inflation, even if that only means you're deflating more slowly.

- The other principle question is how the new monies are introduced to the economy, which is a matter of some debate, for both economic effectiveness and equity. Many have argued that the TARP bailouts were distortionary in that they provided additional financial wealth to banks and other institutions, many of which were directly implicated in the crisis precipitating the bailouts, creating massive perverse incentives. Alternatives would be allocating the funds evenly throughout the economy -- "throwing money out of helicopters" (where, to avoid the obtuse objection of one thick-headed oaf I was discussing this with recently, we make clear that there are lots of helicopters flying high and the money is distributed evenly through the population), or through a lottery (compulsory, you're entered no matter what) such that the distribution is "clumpy" but random -- present wealth or status plays no role in elevating or decreasing your chance of receipt.

And how the monies are destributed has some role in how pricing signals propogate. But in general: more money == higher inflation. Again, even if that means a lower rate of deflation.

The majority of cultures and religions in human history shared the opinion that in general lending for interest leads to instability.

Joking aside... most of the societies that shared this belief tried to justify interest lending as morally dubious rather than presenting reasoned arguments as to why such a practice was unstable.

And perhaps they had a point. There's a difference between predatory lending to pilgrims at a temple and lending for an interest rate that's close to the expected time value of the money borrowed.

But extraordinary claims require extraordinary evidence. I'm inclined to side with today's economists.

"The actual process of money creation takes place primarily in banks. As noted earlier, checkable liabilities of banks are money. These liabilities are customers' accounts. They increase when customers deposit currency and checks and when the proceeds of loans made by the banks are credited to borrowers' accounts.

In the absence of legal reserve requirements, banks can build up deposits by increasing loans and investments so long as they keep enough currency on hand to redeem whatever amounts the holders of deposits want to convert into currency. This unique attribute of the banking business was discovered many centuries ago.

It started with goldsmiths. As early bankers, they initially provided safekeeping services, making a profit from vault storage fees for gold and coins deposited with them. People would redeem their "deposit receipts" whenever they needed gold or coins to purchase something, and physically take the gold or coins to the seller who, in turn, would deposit them for safekeeping, often with the same banker. Everyone soon found that it was a lot easier simply to use the deposit receipts directly as a means of payment. These receipts, which became known as notes, were acceptable as money since whoever held them could go to the banker and exchange them for metallic money.

Then, bankers discovered that they could make loans merely by giving their promises to pay, or bank notes, to borrowers. In this way, banks began to create money. More notes could be issued than the gold and coin on hand because only a portion of the notes outstanding would be presented for payment at any one time. Enough metallic money had to be kept on hand, of course, to redeem whatever volume of notes was presented for payment.

Transaction deposits are the modern counterpart of bank notes. It was a small step from printing notes to making book entries crediting deposits of borrowers, which the borrowers in turn could "spend" by writing checks, thereby "printing" their own money."

Modern Money Mechanics - Federal Reserve Bank of Chicago

[1] http://en.wikisource.org/wiki/Modern_Money_Mechanics/Introdu...

The origins of modern bank notes probably have more to do with the Knights Templar than goldsmiths.

The point you were trying to make is accurate enough, but the source you're quoting is both lengthy and simplistic past the point of being correct.

Coins were around for millenia before paper money. The earliest paper money I know of is the bark money written of by Marco Polo [1]. Europeans got their idea for paper money from the Chinese.

[1] http://www.fee.org/the_freeman/detail/marco-polo-on-money

"Lending" money at 0% interest is monetary inflation. The banks in the federal reserve system are not private except in the sense that their profits are private. No one else gets handed money at virtually 0% interest.

> "inflation" is a virtually inescapable side effect

Are you talking about monetary inflation or price inflation? The lack of this distinction is why these discussions are always pointless.

Very clear explanation on how the money is created (through lending/debt), very informative even if the documentary advocate a monetary reform the beginning is not biased.