Sep 18, 2012
Federal Reserve Now Giving Away More Free Money
Last week, it was big news to economists when Ben Bernanke, chairman of the Federal Reserve, announced that the Fed (as it’s known in business circles) would be instituting a process it calls quantitative easing to help stimulate the economy.
Unless you’re an economist, you’re not likely to have a particularly strong opinion one way or another about quantitative easing, but the move is very important and actually not difficult to understand.
The short way to explain quantitative easing is to say the Fed is going to start printing money out of thin air and they’re going to give that money to banks.
The Fed has been giving $85 billion a month to banks, and they are now going to increase that number to $125 billion a month. This imaginary, interest-free money that the banks are given is supposed to boost the stock market and get banks lending again.
It’s basically the same thing as the stimulus passed in 2009, except that Congress and President Obama don’t have to agree to do it and (because it’s magical Fed money) we can’t ever run out of it. As the late, great rapper ODB once said, “Why would you not want some free money?”
To understand how and why the Fed gets to do this, it’s important to understand a few things about it. First, the job of the Fed is to determine the value of money. That seems like a strange concept, but that’s what the Fed does.
They determine the interest rate for banks to borrow money from them and that determines how much banks charge you. If the Fed is lending money at 5 percent interest, it’s a lot more expensive to borrow than it would be if The Fed were charging 1 percent interest. When interest rates are high banks lend less and money is worth more, conversely when interest rates are low banks should lend more.
Right now, money is very cheap. The Fed is charging right around 0 percent interest—again, “Why would you not want some free money?”—but banks are still slow to lend it to people seeking loans.
The banks are holding onto it because they make more money investing than they do lending. (There used to be a law that kept banks from doing that called the Glass-Steagall Act, but that went out the window in 1999.)
Given that the banks were already getting $85 billion a month, Chairman Bernanke must figure that adding another $40 billion a month indefinitely will be just what the doctor ordered.