How Does the Fed “Print” Money?

You'll often hear people say the Federal Reserve "prints money" in order to fund the federal government's massive budget deficits and ballooning national debt. What exactly does this mean?

The Fed doesn't have a printing press in the basement of the Eccles Building printing dollar bills. But the central bank runs operations that have the same effect -- creating new money out of thin air and expanding the money supply.

This all happens electronically. 

The Fed creates new money when it buys bonds and other assets and adds them to its balance sheet. This is primarily a function of quantitative easing.

The process is relatively straight forward. 

The Fed goes into the open market and buys financial assets including US Treasuries and mortgage-backed securities from banks and other financial institutions. It works just like any other financial transaction. The Fed sends a payment to the bank and the bank transfers ownership of the bonds to the Fed. These assets then sit on the central bank's balance sheet until it sells them back into the open market.

Here's the catch: the Fed doesn't have to have any money in any account to make a purchase.

If you or I buy something, we have to have enough money in our account to cover the purchase. If we don't, the account becomes overdrawn and the bank can decline the transaction. 

Not so for the Fed.

It  can literally creates dollars out of thin air and then transfers them to the banks and financial institutions in return for bonds and other financial assets. In effect, somebody at the Fed presses a few keys and poof -- new money exists. Financial institution can then take these newly acquired funds and lend them to the public. This expands the money supply. 

It also is one of the causes of inflation. 

Debt Monetization

The US government depends on Fed "money printing" to maintain its borrowing and spending. In practice, the central bank creates new money to facilitate government spending.

Here's how it works.

The Federal Reserve uses quantitative easing to "monetize" federal debt. In other words, it turns the national debt into new money. 

When the Fed steps in and buys Treasuries, it creates artificial demand in the bond market. Fed purchases support bond prices and keeps interest rates artificially low. Without this central bank intervention, there wouldn’t be enough demand in foreign and domestic markets to absorb all of the bonds the US Treasury needs to sell. Interest rates would skyrocket and make the cost of borrowing prohibitive.

The massive borrowing during the COVID pandemic reveals the impact of debt monetization.

Between the time it launched QE Infinity in March 2020 and May 2021, the Fed purchased a staggering $2.44 trillion in US government bonds. In effect, the central bank monetized more than half of the US debt accrued.

No other entity has bought more US bonds than the Fed – not foreign investors, not US banks, and not even US corporations and individuals.

So, while the Fed isn't printing money and handing it to federal government, its actions do support borrowing and spending. And the impact on the economy is the same as it would be if it just ran off dollars to pay the governments bills.

Theoretically, the Fed can sell the bonds and pulls the dollars out of the economy. Ben Bernanke promised this would happen when he launched QE1 in 2008. But it never happened. In effect, the Fed serves as a permanent source of liquidity for the federal government.