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Do You Know How The Fed Pumps Up The Money Supply?

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Do you know how the Federal Reserve "pumps" money into the economy? Recently, the news media have reported that the Federal Reserve has "pumped" money into the economy, but they do not explain exactly how the Fed does this.

One of the fundamental functions of government is to control the money supply. The more you understand how governments control the amount of money in the economic system, in a global economy, the better you can take control of your own personal economic system.

Every nation has its own central bank. One of the functions of a central bank is to respond to current economic situations to either cool down or heat up the economy. In the United States, the central bank is the Federal Reserve.

Although the news media use this type of language, they don't explain exactly how the Fed increases or decreases the amount of money. What does the Fed do when the media report that the Fed is "pumping money" into the economy to calm fears of an economic panic? What does it do to "drain money" from the system, to cool it down?

First, it's important to be clear what it does NOT mean. The Fed does not pump more money into the system by printing more currency. Currency is not equivalent to money.

The Fed can control the money supply with several methods.

One method involves the reserve requirements for banks. A bank must keep a portion of its deposits on reserve. In other words, the bank can only loan out a percentage of its deposits as loans. The percentage it cannot loan out is the reserve.

If you have ever wondered how banks make money, they make it by loaning out customers deposits to other customers. However, the bank cannot loan out all of its deposits. If you deposit $1,000 in the bank, the bank loans most, but not all, of your $1,000 to other customers.

The Federal Reserve sets the reserve requirements for banks. The banks must keep 3-10% of customer deposits on reserve. This means that the bank needs to keep on reserve only 3-10% of your $1,000. With a 10% reserve, the bank must keep $100 on reserve. That means it can loan out the remaining $900. With a 3% reserve, the bank must keep only $30 on reserve. It is allowed to loan out the remaining $970.

This example demonstrates that the Fed can control the amount of money banks can loan by changing the how much the banks must keep on reserve. When the Fed wants to "pump" money into the system, it reduces the reserve requirements. The same process works in the opposite direction. The Fed can "drain" money from the system if it increases the reserve requirements.

When the bank has to keep 10% of its deposits on reserve, it can loan out only 90% of its deposits. When the bank has to keep only 3% of its deposits on reserve, it can loan out 97% of its deposits to customers. With a lower reserve, more money is available. With a higher reserve, less money is available. .

So, the reserve requirement is one way that the Fed controls the amount of money in the economic system. This is why it is not exactly accurate to claim that the Fed "pumps" more money into the system. The banks are the ones pumping more money into the system, and they do that because the Fed reduced the reserve requirement.

Article Source: http://www.articlesinsight.com

Kalinda Rose Stevenson, Want to find out how investors use money? Find out how in a real estate investing book about the world's most popular board game. How would you like a www.accesstoprivatemoney.com">private money investor for huge projects?

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