Understanding How the Federal Reserve Creates Money (2024)

The Federal Reserve System is the central bank of the United States. Referred to as the Fed, it is arguably the most influential economic institution in the world. One of the chief responsibilities set out in the Fed's charter is the management of the total outstanding supply of U.S. dollars and dollar substitutes. That means the Fed is responsible for the policies that create or destroy billions of dollars every day.

Despite being charged with managing the money supply, the modern Federal Reserve does not simply run new paper bills off of a machine. Of course, real currency printing does occur (with the help of the U.S. Department of the Treasury). However, the vast majority of the American money supply is digitally debited and credited to commercial banks. Moreover, real money creation takes place after the banks loan out those new balances to the broader economy.

Key Takeaways

  • The Federal Reserve, as America's central bank, is responsible for controlling the supply of U.S. dollars.
  • The Fed creates money by purchasing securities on the open market and adding the corresponding funds to the bank reserves of commercial banks.
  • The Fed uses the federal funds rate to affect other interest rates and adjust the money supply.
  • To combat the recession caused by COVID-19, the Fed lowered the reserve requirement for banks to zero.

Printing Money

Printing money is the job of the Federal Reserve, but only figuratively speaking. When the Fed decides to stimulate the economy by pouring more money into the system, it electronically transfers additional credits to the deposits of its member banks.

How Does the Federal Reserve Work?

The Federal Open Market Committee (FOMC) and associated economic advisers meet regularly to assess the U.S. money supply and general economic conditions. If it's determined that new money needs to be created, then the Fed targets the amount of money needed and institutes a corresponding policy to inject it into the economy.

It's hard to track the actual amount of money in the economy because many things can be defined as money. Obviously, paper bills and metal coins are money. Savings accounts and checking accounts represent direct and liquid money balances. Money market funds, short-term notes, and other reserves are also often counted. Nevertheless, the Fed can only estimate the money supply.

How the Fed Increases the Money Supply

The Fed could initiate open market operations (OMO), where it buys or borrows Treasury bills from commercial banks to inject money. The central bank will add cash to the accounts, called bank reserves, that banks are required to keep. That increases the money supply. On the other hand, if the Fed sells or lends treasuries to banks, the payment it receives in exchange will reduce the money supply.

Types of Money

The various types of money in the money supply are generally classified as Ms, such as M0, M1,M2, and the discontinuedM3, according to the type and size of the account in which the instrument is kept.

Known as monetary aggregates, not all of the classifications above are widely used. Different countries may use different classifications. The money supply reflects theliquiditythat each type of aggregate has in the economy. It is broken up into different categories of liquidity (or spendability).

Use of Monetary Aggregates

The Federal Reserve uses monetary aggregates as a metric for how open-market operations, such astrading in Treasury securities or changing the discount rate, affect the economy.

Investors and economists observe the aggregates closely because they offer an accurate depiction of the actual size of the country’s working money supply. By reviewing the monthly reports ofM1andM2data, investors can measure the money aggregates' rate of change and monetary velocity overall.


The importance of the money supply as a guide for monetary policy isn't as great as it once was. However, the Fed still studies money supply figures regularly.

Understanding the Federal Funds Rate

The target federal funds rate is a suggested interest rate set by the FOMC based on its view of the country's economic health. It's used by banks as a guide for the interest rate to charge each other for overnight loans of excess reserves.

The fed funds rate is an important tool used by the Fed to influence other interest rates and affect the money supply. For instance, by lowering the rate, banks follow suit and lower the rates they charge on products such as consumer loans and credit cards.

Due to the severity of the COVID-19 pandemic and its negative effect on economic activity, in March 2020, the Fed Board reduced to zero the reserve requirement ratio banks must use. This eliminated the reserve requirement for all depository institutions.

Another Way the Fed Creates Money

In the early days of central banking, money creation was a physical reality. New paper notes and new metallic coins would be crafted, imprinted with anti-fraud devices, and released to the public (almost always through some favored government agency or politically-connected business).

Central banks have become much more technologically creative since then. The Fed figured out that money doesn't have to be physically present to work in an exchange of money for goods and services. Businesses and consumers could use checks, debit and credit cards, balance transfers, and online transactions.

Money creation doesn't have to be physical, either. It needn't be printed. The country's central bank can simply determine the new dollar balances needed and credit them to other accounts.

Today's Federal Reserve buys new, readily liquefiable accounts, such as U.S. Treasuries, on the open market from financial institutions to add funds to their existing bank reserves. This has the same effect as printing new bills and transporting them to the banks' vaults (but it's cheaper). The newly credited balances count just as much as physical bills in the economy. They can also be just as inflationary.

Fed Funds Rate Increase

During its March 2022 meeting, the FOMC directed that the federal funds target interest rate be raised by 0.25% to a range of 0.25% to 0.50%. This is the first increase since 2018 and was undertaken in an effort to combat record-breaking inflation. A couple of months later at the next FOMC meeting, the committee raised the rate again to a range of 0.75% to 1%.

The Credit Market Funnel

Suppose the U.S. Treasury prints $10 billion in new bills. In addition, the Federal Reserve credits $90 billion in readily liquefiable accounts. At first, it might seem like the economy just received a monetary influx of $100 billion. However, that's only a very small percentage of the potential total amount of money created.

This is because of the role of banks and other lending institutions that receive new money. Nearly all of that $100 billion enters banking reserves.

The credit markets have become a funnel for money distribution. In a fractional reserve banking system, new loans actually create even more new money. Despite a legally required reserve ratio of, normally, 10%, the new $100 billion in bank reserves could potentially result in a nominal monetary increase of $1 trillion.

The Federal Reserve Bank must destroy currency when it is damaged or otherwise fails to meet its standard of quality.

Does the Fed Print Money?

No. The actual printing of paper money is handled by the Treasury Department's Bureau of Engraving and Printing. The U.S. Mint produces the country's coins.

Do Banks Create Money?

Yes. Every time banks loan funds to consumers and businesses they create new money. That loaned money, in turn, gets deposited back into the banking system where it gets loaned again, creating more new money.

How Much New Money Is Created Each Year?

That depends on decisions made by the Fed that concern the country's economic well-being and whether the money supply should be increased to affect it. As for the actual amount of printed money, the Board of Governors of the Fed provides the Treasury Department with an order each year for the amount of paper money to print.

Who Is the Chair of the Federal Reserve Board?

Jerome Powell is the current Chair of the Board of Governors of the Federal Reserve. He took office in February 2018. In February 2022, the Board named Powell Chair Pro Tempore pending the Senate confirming him for a second four-year term.

The Bottom Line

The Federal Reserve creates money when it decides that the economy would benefit by it doing so. It creates money not by printing currency but by effectively adding funds to the money supply.

The Fed does this in various ways, including changing the target fed funds rate with the goal of affecting other interest rates. Or it may buy Treasury securities on the open market to add funds to bank reserves. Banks create money by lending excess reserves to consumers and businesses. This, in turn, ultimately adds more to money in circulation as funds are deposited and loaned again.

The Fed does not actually print money. This is handled by the Treasury Department's Bureau of Engraving and Printing. The U.S. Mint makes the country's coins.

Correction—Dec. 2, 2022: This article was corrected from a previous version that referred to the now obsolete money multiplier approach. The central bank doesn't determine the quantity of loans and deposits in the economy by controlling the quantity of reserves, but by setting the price of reserves—that is, interest rates.

Understanding How the Federal Reserve Creates Money (2024)


Understanding How the Federal Reserve Creates Money? ›

It creates money not by printing currency but by effectively adding funds to the money supply. The Fed does this in various ways, including changing the target fed funds rate with the goal of affecting other interest rates. Or it may buy Treasury securities on the open market to add funds to bank reserves.

How does the Federal Reserve create money? ›

The Federal Reserve uses open-market operations to either increase or decrease reserves. To increase reserves, the Federal Reserve buys U.S. Treasury securities by writing a check drawn on itself. The seller of the treasury security deposits the check in a bank, increasing the seller's deposit.

How can the Federal Reserve actually increase the money supply? ›

If the Fed, for example, buys or borrows Treasury bills from commercial banks, the central bank will add cash to the accounts, called reserves, that banks are required keep with it. That expands the money supply.

What is the main reason the Federal Reserve controls the amount of money in the economy? ›

3. Conducting Monetary Policy. The Federal Reserve sets U.S. monetary policy to promote maximum employment and stable prices in the U.S. economy.

How does the Federal Reserve impact the value of money? ›

The Fed uses three primary tools in managing the money supply and pursuing stable economic growth. The tools are (1) reserve requirements, (2) the discount rate, and (3) open market operations. Each of these impacts the money supply in different ways and can be used to contract or expand the economy.

Does the Federal Reserve produce money? ›

Each year, the Federal Reserve Board projects the likely demand for new currency, and places an order with the Department of the Treasury's Bureau of Engraving and Printing, which produces U.S. currency and charges the Board for the cost of production.

Can the Federal Reserve create its own money? ›

Smaller commercial banks such as community banks and credit unions have zero reserve requirement. The Federal Reserve can only create new money as debt as well, during quantitative easing they buy U.S. Treasuries and mortgage-backed securities.

How is money created? ›

Banks create money during their normal operations of accepting deposits and making loans. In this example we'll use M1 as our definition of money. (M1 = currency in our pockets and balances in our checking accounts.) When a bank makes a loan it creates money.

Who controls all of our money? ›

To ensure a nation's economy remains healthy, its central bank regulates the amount of money in circulation. Influencing interest rates, printing money, and setting bank reserve requirements are all tools central banks use to control the money supply.

Who controls the Federal Reserve? ›

The Board of Governors--located in Washington, D.C.--is the governing body of the Federal Reserve System. It is run by seven members, or "governors," who are nominated by the President of the United States and confirmed in their positions by the U.S. Senate.

What banks own the Federal Reserve? ›

The Federal Reserve System is not "owned" by anyone. The Federal Reserve was created in 1913 by the Federal Reserve Act to serve as the nation's central bank. The Board of Governors in Washington, D.C., is an agency of the federal government and reports to and is directly accountable to the Congress.

What are the three ways that the Federal Reserve impacts the money supply? ›

To conduct monetary policy, the Fed relies on three tools: reserve requirements, the discount rate, and open market operations.

What are three major duties of the Federal Reserve? ›

How the Fed Helps the Economy. The Federal Reserve acts as the U.S. central bank, and in that role performs three primary functions: maintaining an effective, reliable payment system; supervising and regulating bank operations; and establishing monetary policies.

Can inflation be reversed? ›

The reverse of inflation is called disinflation. The central bank can reverse inflation by implementing various tools: 1. Monetary policy: in monetary policy central bank generally increases the interest rate that reduces investment and economic growth.

What is the major asset of the Federal Reserve? ›

Securities held outright make up about 94 percent of the Fed's total balance sheet. Nearly two-thirds are Treasury securities, including shorter-term Treasury bills, notes and bonds. Mortgage-backed securities make up another almost one-third.

What are the three tools for controlling the money supply? ›

The Fed has three major tools that it can use to affect the money supply. These tools are 1) changing reserve requirements; 2) changing the discount rate; and 3) open market operations. The book discusses these tools of monetary policy on pages 389 - 395.

How does the Federal Reserve actually work? ›

It is responsible for managing monetary policy and regulating the financial system. It does this by setting interest rates, influencing the supply of money in the economy, and, in recent years, making trillions of dollars in asset purchases to boost financial markets.

Who does the US owe money to? ›

Nearly half of all US foreign-owned debt comes from five countries.
Country/territoryUS foreign-owned debt (January 2023)
United Kingdom$668,300,000,000
6 more rows

Who controls the money in the Federal Reserve? ›

The Board of Governors guides the operation of the Federal Reserve System to promote the goals and fulfill the responsibilities given to the Federal Reserve by the Federal Reserve Act. All of the members of the Board serve on the FOMC, which is the body within the Federal Reserve that sets monetary policy.

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