Have you seen the news reports that the Federal Reserve has "pumped" money into the economy? Have you wondered exactly what that means? How exactly does the Fed "pump" more money into the system? You might be wondering how this matters to you. The fact is that the more you understand how governments control money, the better you will be able to take control of your own economic situation, especially in a global economy. One of the primary functions of a government is to control the amount of money in the system. Every nation has a central bank. In the United States, the central bank is the Federal Reserve. The central banks pay attention to the condition of the current economic conditions, and then take actions to either heat up or cool down the economy. 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. The first tool the Fed uses is to adjust the reserve requirement of banks. The "reserve" is the portion of customer deposits that the bank must keep. It cannot loan all of its deposits. Banks make money by loaning out customer deposits to other customer deposits. This means that if you deposit $1,000 in the bank, the bank loans most of your money to other customers. However, the bank is not allowed to loan out the full $1,000. The Federal Reserve requires banks to keep on reserve 3-10% of its deposits, and allows the banks to loan the rest. In the case of your $1,000, this means that the bank needs to keep only 3-10% of your $1,000 on reserve. With a 3% reserve, the bank must keep only $30 on reserve, and is allowed to loan out the remaining $970. With a 10% reserve, the bank must keep $100 on reserve and is allowed to loan out only $900. The Fed can use the reserve requirements to control the amount of money banks have available to loan. If the Fed wants to increase the amount of money in the economy, it reduces the reserve requirements. If it wants to decrease the amount of money, it increases reserve requirements. This is how the Fed "pumps" money into the system and "drains" money from the system. With a lower reserve requirement, the bank has more money to loan. With a higher reserve requirement, the bank has less money to loan. This is the difference between loaning out 97% of its deposits with a 3% reserve rate and 90% of its deposits with a 10% reserve rate. The changes in reserve rates increase and decrease the money supply. 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.
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Kalinda Rose Stevenson, Want to discover investor money rules? Find out how in a real estate investing book on the world's most well-loved board game. Do you need a www.accesstoprivatemoney.com">private money investor for big projects?
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