How do you inject money into the economy?

Answers to your questions about the news.
Aug. 16 2007 6:46 PM

How Do You Inject Money Into the Economy?

With an auction.

The U.S. Federal Reserve pumped $62 billion into the banking system over two days last week as credit fears spread and stock markets sank—a situation that's been likened to financial Armageddon. On Thursday, the Fed injected another $17 billion. How exactly do you put cash into the market?

With huge short-term loans. The Fed auctions off these loans to the banks willing to pay the highest interest rates. For collateral, the borrowers use their government bonds and bonds and mortgage-backed securities issued by Freddie Mac, Fannie Mae, or Ginnie Mae—buying them back from the government after a period of at most two weeks. *  In the meantime, the banks have more cash to lend—to each other, to corporations, to anyone who's buying a house or car.

Advertisement

To initiate one of these temporary loans, the Federal Reserve Bank of New York, which handles the central bank's transactions, posts a message on its electronic auction system. Within 15 minutes, the 21 so-called "primary dealers," the likes of Goldman Sachs and Morgan Stanley, can submit interest rates they're willing to pay to borrow; the highest ones are accepted. On Thursday, banks paid 4.8 percent or more in interest. The borrowers don't actually receive the cash until a designated commercial bank—either the Bank of New York or Chase—executes the electronic transaction.

These infusions help to keep a tight leash on something called either the "overnight lending rate" or the "fed funds rate." Banks are required by law to maintain about 10 percent of all their checking deposits in cash. *To make sure they have the right amount at the end of each day, they borrow from one another using the overnight lending rate.

If too many banks start borrowing money to cover their cash reserves, then the lenders can start charging higher interest rates. And if the rates get too high, banks will have to cover their reserves by lending less money to businesses and individuals. That slows down the whole economy. But the Fed can take action to keep the overnight lending rate steady. By injecting cash, the government makes it so that banks don't need to borrow as much from one another—which causes the rate to drop. (The Fed can also take money out of the market to make the rate go up.)

The recent infusions were especially big, but the government pours money into the market all the time. Doesn't all this extra cash lead to inflation? Only if the Fed starts handing out more help than the banks need—if the supply of money exceeds the demand from banks. If banks were so flush with cash that they could use the government's loan for something else besides covering their reserves—like buying new technology or lending the money to their customers—then the cash would enter the general market, wind up in somebody's wallet, and push up the price of goods.

Got a question about today's news? Ask the Explainer.  

Explainer thanksDavid Beim of Columbia University and John Coleman of Duke University.

Corrections, Aug. 21, 2007: The original version failed to say that banks use bonds and mortage-backed securities issued by Freddie Mac, Fannie Mae, or Ginner Mae for collateral. (Return to the corrected sentence.) It also stated incorrectly that banks are required by law to maintain 10 percent of deposits as reserves. According to the Monetary Control Act of 1980, they must hold between 8 and 14 percent of their checking (not total) deposits in reserve, as specified by the Fed. (Return to the corrected sentence.)

Michelle Tsai is a Beijing-based writer working on a book about Chinatowns on six continents. She blogs at ChinatownStories.com.

TODAY IN SLATE

Culturebox

The Ebola Story

How our minds build narratives out of disaster.

The Budget Disaster That Completely Sabotaged the WHO’s Response to Ebola

PowerPoint Is the Worst, and Now It’s the Latest Way to Hack Into Your Computer

The Shooting Tragedies That Forged Canada’s Gun Politics

A Highly Unscientific Ranking of Crazy-Old German Beers

Education

Welcome to 13th Grade!

Some high schools are offering a fifth year. That’s a great idea.

Culturebox

The Actual World

“Mount Thoreau” and the naming of things in the wilderness.

Want Kids to Delay Sex? Let Planned Parenthood Teach Them Sex Ed.

Would You Trust Walmart to Provide Your Health Care? (You Should.)

  News & Politics
Politics
Oct. 22 2014 9:42 PM Landslide Landrieu Can the Louisiana Democrat use the powers of incumbency to save herself one more time?
  Business
Continuously Operating
Oct. 22 2014 2:38 PM Crack Open an Old One A highly unscientific evaluation of Germany’s oldest breweries.
  Life
Gentleman Scholar
Oct. 22 2014 5:54 PM May I Offer to Sharpen My Friends’ Knives? Or would that be rude?
  Double X
The XX Factor
Oct. 22 2014 4:27 PM Three Ways Your Text Messages Change After You Get Married
  Slate Plus
Tv Club
Oct. 22 2014 5:27 PM The Slate Walking Dead Podcast A spoiler-filled discussion of Episodes 1 and 2.
  Arts
Culturebox
Oct. 22 2014 11:54 PM The Actual World “Mount Thoreau” and the naming of things in the wilderness.
  Technology
Future Tense
Oct. 22 2014 5:33 PM One More Reason Not to Use PowerPoint: It’s The Gateway for a Serious Windows Vulnerability
  Health & Science
Wild Things
Oct. 22 2014 2:42 PM Orcas, Via Drone, for the First Time Ever
  Sports
Sports Nut
Oct. 20 2014 5:09 PM Keepaway, on Three. Ready—Break! On his record-breaking touchdown pass, Peyton Manning couldn’t even leave the celebration to chance.