The Federal Reserve, like any bank, can acquire an asset simply by crediting a bank account. In other words, the bank pays by creating money. As Alan Greenspan explained, the Fed has an unlimited capacity to spend in US dollars. It can pay trillions of dollars with a single keystroke. Here is
Chairman Bernanke (Readers can follow is presentation beginning on page 17):
“Now, you might ask the question, well, the Fed is going out and buying 2 trillion dollars of securities – how did we pay for that? And the answer is that we paid for those securities by crediting the bank accounts of the people who sold them to us, and those accounts, at the banks, showed up as reserves that the banks would hold with the Fed. So the Fed is a bank for the banks. Banks can hold deposit accounts with the Fed, essentially, and those are called reserve accounts. And so as the purchases of securities occurred, the way we paid for them was basically by increasing the amount of reserves that banks had in their accounts with the Fed.
So you can see this, here, this is the liabilities side of the Fed’s balance sheet. Of course, assets and liabilities (including capital) have to be equal. So the liabilities side had also to rise near 3 trillion dollars, as you can see.
Now, take a look first, as you look at this, take a look first at the light blue line at the bottom. The light blue line at the bottom is currency – Federal Reserve notes in circulation. Sometimes you hear that the Fed is printing money in order to pay for the securities we acquire. And I’ve talked about that in some, you know, in giving some conceptual examples. But as a literal fact, the Fed is not printing money to acquire these securities, and you can see it from the balance sheet here, the light blue line is basically flat. The amount of currency in circulation has not been affected by these activities.
What has been affected is the purple area. Those are reserve balances. Those are that accounts that banks, commercial banks, hold with the Fed, and they are assets of the banking system and they are liabilities of the Fed, and that’s basically how we paid for those securities. And so, the banking system has a large quantity of these reserves, but they are electronic entries at the Fed. They basically just sit there. They’re not in circulation. They’re not part of any broad measure of the money supply. They’re part of what’s called the monetary base, but again, they’re not, they certainly aren’t cash.[.......]
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