Creating Money Out of Thin Air

The Federal Reserve pumped an extra $1 trillion into the financial system by purchasing Treasury bonds. They did this earlier this year. This represented a significant effort to bolster the economy--and help the US get out of its recession.


This amounts to creating vast new sums of money out of thin air--just as this man standing next to $1 billion in $100 bills sees.


This action makes the Fed a buyer of long-term government bonds rather than the short-term debt that it typically buys and sells to help control the money supply.

The idea is to encourage more economic activity by lowering interest rates, including those on home loans, and to help the financial system as it struggles under the crushing weight of bad loans and poor investments.

The Fed’s action is an expansion of its effort to bypass the private banking system and act as a lender in its own right.

There are risks, however, in doing this. It could dilute the value of the dollar and set the stage for future inflation.

The Fed rarely buys long-term government bonds. The last time was nearly 50 years ago under different economic circumstances when it tried to reduce long-term interest rates while allowing short term rates to rise.

But these are trying times. The US is in a severe recession. Job losses are high and lost housing wealth is significant.

In these circumstances, the Federal Reserve will employ all available tools to promote economic recovery and to preserve price stability, says a Fed spokesman.