Fed, central bankers likely to pull back stimulus

The Federal Reserve has indicated that it will be pulling back on its stimulus sooner rather than later. What does that really mean?

The Federal Reserve has indicated that it will be pulling back on its stimulus sooner rather than later. What does that really mean? I still get asked by clients what it means when the Fed prints money, does it mean they will start producing more dollar bills?

Not exactly. The Federal Reserve usually decides a couple of months ahead of the new fiscal year how much cash it needs to print — much of it simply to retire old bills. It sends its annual order to the Bureau of Engraving and Printing. Those bills enter circulation through banks which are required to keep money in a reserve account with the Fed. When people cash cheques or take money from the ATM, those banks replenish their cash supply by getting currency from a Fed branch, with the amount debited electronically from the bank’s reserves. The amount of currency in circulation can vary from day to day and season to season: More people want cash during the holidays, for example.

Although the stock of currency in circulation has increased dramatically over the years, there is no immediate evidence that the bureau is working its printing presses overtime or has any plans to do so.

So what do people mean when they say the Fed might choose to “print money”? In practice, the term is often used as shorthand for what economists call quantitative easing. Typically, major monetary-policy decisions by the Fed are made by setting a target for the federal funds rate — the interest rate at which banks lend to other banks — and then buying or selling government securities to achieve that goal. But as the targeted federal funds rate nears zero the Fed may be forced to look at other options to fight off possible deflation. (Japan has found itself facing similar problems in recent years.) Quantitative easing is an attempt to increase the money supply by buying more and more assets from banks without regard to an interest-rate target. The Fed doesn’t need to print more currency to do that; it can simply happen electronically, as the banks are credited with more money in the accounts they keep with the Federal Reserve. The Fed can do this as much as it wants, but it could face two problems. It’s possible that those reserve accounts will keep growing without stimulating any economic activity. Alternatively, the Fed could increase the money supply by too much, resulting in inflation.

Stuart Kirk is a Wealth Advisor with Precision Wealth Management Ltd. The opinions expressed are those of the author and may not necessarily reflect those of Precision Wealth Management Ltd. For comments or questions he can be reached at stuart@precisionwealth.ca, 250-954-0247 or www.precisionwealth.ca.

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