Gavin - More Money: Understanding Recent Changes in the...

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FEDERAL RESERVE BANK OF ST. LOUIS REVIEW MARCH/APRIL 2009 49 More Money: Understanding Recent Changes in the Monetary Base William T. Gavin The financial crisis that began in the summer of 2007 took a turn for the worse in September 2008. Until then, Federal Reserve actions taken to improve the functioning financial markets did not affect the monetary base. The unusual lending and purchase of private debt was offset by the sale of Treasury securities so that the total size of the balance sheet of the Fed remained relatively unchanged. In September, however, the Fed stopped selling securities as it made massive purchases of private debt and issued hundreds of billions of dollars in short-term loans. The result was a doubling of the size of the monetary base in the final four months of 2008. This article discusses the details of the programs that the Fed has initiated since the crisis began, shows which programs have grown as the monetary base grew, and discusses some factors that will determine whether this rapid increase in the monetary base will lead to rapid inflation. (JEL E31, E42) Federal Reserve Bank of St. Louis Review , March/April 2009, 91 (2), pp. 49-59. we should expect to see high inflation following such rapid monetary growth. Figure 1 shows that this rapid surge in the monetary base is concentrated entirely in the accumulation of bank reserves. (Throughout this article, the generic word “bank” is used instead of the official term, “depository financial institu- tion.”) Bank deposits at the Fed include three components. Two are small and have changed little since the economic crisis began in August 2007; they are deposits used to satisfy reserve requirements and those used to satisfy required clearing balances. 2 The third component, “excess reserves,” accounts for the doubling of the mone- tary base. This rapid increase is directly related to Federal Reserve programs initiated or expanded T he monetary base is the sum of cur- rency in circulation and bank deposits at Federal Reserve Banks. Between mid- September and December 31, 2008, the U.S. monetary base increased from approxi- mately $890 billion to $1,740 billion, doubling in a little more than 3 months. 1 This is a concern because, under normal circumstances, we would associate such a rapid rise in the monetary base with a sharp acceleration of inflation. But today, more people seemed to be worried about deflation than a sudden rebound of inflation. The purpose of this article is to explore the sources of growth in the monetary base and to ask whether or not 1 These data are derived from the Fed’s H4.1 release ( This measure of the monetary base is named as the series WSBASE on the Federal Reserve Bank of St. Louis’s FRED database. For technical reasons (adjustments for seasonal factors, reserve requirements, carryover, “as of,” and cash items in process of collection), the numbers here do not correspond to either the Board of Governor’s measure of
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This note was uploaded on 03/27/2012 for the course GEOL 2413 taught by Professor Moody during the Spring '10 term at Texas A&M University, Corpus Christi.

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Gavin - More Money: Understanding Recent Changes in the...

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