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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. The news media use colorful language to say that the Fed is "pumping money" into the economy to calm fears of an economic panic. In other situations, the media refer to actions of the Fed intended to "drain money" from the system. Even though the media report that the Fed "pumps" money or "drains" money, they don't explain clearly how the Fed does this. How exactly does the Fed increase or decrease the amount of money? Before we figure out what it means, let's establish clearly what it does NOT mean. The Fed does not pump money into the system by printing out more currency. Currency is not equivalent to money. The Fed has several tools it can use to decrease or increase the amount of money in the system. One method is to change the reserve requirements of banks. The "reserve" is the percentage of customer deposits that the bank must not loan out. In other words, a bank must keep a certain percentage of its deposits on "reserve." 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 sets the reserve requirements for banks. Typically, the reserve ranges from 3-10% of its deposits. So, with your $1,000 deposit, the bank needs to keep on reserve only $30 with a 3% reserve and $100 with a 10% reserve. The bank is free to loan out whatever is left after the reserve requirement. With a 3% reserve the bank can loan out $970 of your money. With a 10% reserve, the bank can 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.
Article Source: http://www.financemanual.com
Kalinda Rose Stevenson, Want to discover how investors use money? Learn 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 huge projects?
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