The Fed starts a two-day meeting Tuesday. And while Ben Bernanke isn't expected to change rates, a lot is on the line.
You probably have a sense the Fed is super important and powerful, but here's something you probably don't know: The Fed doesn't print money.
Yes, that's right. Despite all the chatter on the campaign trail (hello, Ron Paul) and on cable TV, the Fed is actually not in the business of printing money.
In America, the actual, physical printing presses are owned and operated by the Treasury Department...not the Fed.
A lot of people are confused about this. That's probably because the Fed does control the money supply. But "money supply' is not the same as actual physical dollars — and yet another reason why economics is known as "the dismal science".
The money supply equals the amount of physical cash plus the amount of credit circulating throughout the economy, which is where the Fed comes in a very big way.
Think of the Fed as a bank — but just for other banks. The Fed lends money to banks, which determines the rate which banks charge the rest of us for everything from car loans to mortgages to credit card rates and pretty much every other loan you can think of (and some fees only a banker can dream up.)
By setting the rate banks can borrow from the Fed, non-ironically called "the discount rate", the Fed helps determine whether rates are high or low for the rest of us. And those rates help determine whether people want to borrow money or not.
In addition to the discount rate, there's the fed funds rate, which is the rate you usually hear people talking about when it comes to the Fed. The fed funds rate is the rate banks charge to other banks for overnight loans, which is common practice in the world of high finance. Technically, the Fed sets a 'target' fed funds rate, and currently it's between 0% and 0.25%, where it's been since December 2008.
Another way the Fed controls the money supply — again, which is different than the actual amount of dollars in circulation — is via its "open market operations", through which it buys and sells bonds in the open market. If you've read news stories about the Fed buying Treasuries to help boost the economy, that's an example of 'open market operations' in action and is an example of "quantitative easing" or QE, which is not to be confused with a ship.
When it buys bonds, the money supply increases because the banks exchange their bonds for cash and then have more money -- aka liquidity -- to lend to businesses or individuals. The opposite occurs when the Fed sells bonds to the banks, who typically can't refuse any offer from the Fed.
In addition, the Fed controls the money supply by raising or lowering "reserve requirements," which is the amount of money banks are required to keep "on reserve" at the Fed, sort of like a rainy-day fund for the banking system. Raise those requirements and banks have less money for other stuff -- like lending; the opposite is true when the Fed lowers reserve requirements...or keeps them low as has been its recent practice.
For more detail on how this all works, see the Fed's comic book: The Story of the Federal Reserve System.
So while the Fed doesn't technically (or actually) print physical dollars, it has an enormous impact in the amount of money and credit in our economy. The real scandal is the banks pretty much have to do what the Fed wants, which makes Ben Bernanke the equivalent of a "Godfather" figure in the world of high finance.
And you thought Wall Street was powerful?
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- Finance/Investment & Company Information/Central Banks