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The Fed in 2012 – By Mises Institute

The Federal Reserve increased the money supply by purchasing assets of questionable quality from the banking system. It paid for these assets with cash (an increase in Federal Reserve notes) and received the assets now entered on its balance sheet (mostly mortgage-backed securities and Federal Agency debt). If banks took the fresh money and lent it out to borrowers to spend in the economy, inflationary pressures would build on prices. To avoid this outcome, the Fed commenced paying interest on reserve balances (both required and excess). Banks would hold on to the new reserves, earn a small profit, and improve their capital positions. Even though the interest rate offered on reserves was meager (only 0.25 percent as of today), banks by-and-large chose this path rather than risk parting with their money, and perhaps losing it, through loans to private companies and individuals. It was a win-win solution. Banks received a capital infusion and remained solvent. The Fed “saved” the banking sector while not provoking an inflationary run-up in prices.

The Fed can stave off inflation only as long as the banking system…

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