NCPA - National Center for Policy Analysis

How The Federal Reserve Creates Money

October 11, 1999

The Federal Reserve, America's central bank, is a mysterious institution to most people. One would expect a member of the House Committee on Banking and Financial Services, which oversees the Fed, to be reasonably knowledgeable on the subject. But at least one committee member, Congressman Jack Metcalf (R-Wa.), seems to have no clue at all.

Metcalf says every American is paying $100 per year just to get the cash they spend. If the Treasury issued this money, Metcalf believes, the Federal Government would save $25 billion per year.

What the confused congressman is talking about is the fact that the Fed conducts monetary policy by buying and selling U.S. Treasury securities. When it buys the money supply expands; when it sells the money supply contracts. The vast bulk of the money created in the process consists of bank balances. Only a tiny percentage involves the printing of currency, which is done by the Treasury's Bureau of Engraving and Printing.

  • As of June 30, the Fed held $494 billion in Treasury securities, and last year it received $26.8 billion in interest from the Treasury -- the tax Congressman Metcalf is upset about.
  • But the Federal Reserve sends virtually all of this money back to the Treasury and it is counted as government revenue -- in 1998, the Treasury got a check from the Federal Reserve for $24.5 billion.
  • The difference goes to pay for Federal Reserve operations and salaries.

So there really is no tax. It is just a bookkeeping transaction. Taxpayers would save nothing by converting Federal Reserve notes to Treasury notes.

However, the Federal Reserve's expenses ultimately do come out of the taxpayer's pocket. An article in the August 2 issue of Barron's details the sharply rising cost of operating the 12 regional Federal Reserve banks.

Source: Bruce Bartlett, senior fellow, National Center for Policy Analysis, October 11, 1999.

 

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