Question about the Fed, and monetary policy.

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KingGheedora

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Jun 24, 2006
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I've been reading some blogs, and books, and keep seeing it mentioned that the fed increases the supply of money by buying up Treasuries. Can anyone explain how buying treasuries increases the supply of money? It gives the US Gov. more money, but then the government will have to pay it back with interest, so how is monetary supply increased in any way?

And what does the government do with this money? Does it go into the same pool as the money they get from income taxes?

Given that the current yields for 10-years are around 2-3%, couldn't they just take all the money they are making right now and use it to pay back higher-interest debt from previous years? I'm guessing they mostly will pay it to Social Security, Medicare, defense, and the tiny amount left after that will go to various programs, including a tiny amount towards servicing existing debt.
 

ManSnake

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Oct 26, 2000
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By purchasing government debt, the Fed is basically writing a check to the holders of the debt (not the government). The holders in turn deposit the check in the bank, thus the money supply increases. To decrease the supply just think in reverse.
With increased money supply, the hope is to keep interest rates low, which should normally promote investments.

A majority of the the people on TV or blogging about these things have never taken a macroeconomic course so they don't know what they are talking about. Listening to them would only confuse you more.
 

tailes151

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Mar 3, 2006
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Think of it this way, when the government buys treasuries, it is buying them from individuals holding those treasuries. A lot of those individuals are in the US. They get cash from the government, the government gets a piece of paper saying it has the rights to the government security.

In reverse, when the government sells the treasuries, it hands out pieces of paper in exchange for money, thus decreasing the money supply.

It's kind of counter-intuitive but you'll get the hang of it.
 

KingGheedora

Diamond Member
Jun 24, 2006
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Think of it this way, when the government buys treasuries, it is buying them from individuals holding those treasuries. A lot of those individuals are in the US. They get cash from the government, the government gets a piece of paper saying it has the rights to the government security.

In reverse, when the government sells the treasuries, it hands out pieces of paper in exchange for money, thus decreasing the money supply.

It's kind of counter-intuitive but you'll get the hang of it.

Makes a little more sense now. I always thought that treasuries were only bought from from the government.

But let's say I bought a 10 year treasury 5 years ago, at a rate of 4%. Today a 10-year yields .4%. My treasury still yields 4% right? And so people will pay more for the one I have over the low-yielding ones available from the government today, correct?
 

tailes151

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Mar 3, 2006
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Makes a little more sense now. I always thought that treasuries were only bought from from the government.

But let's say I bought a 10 year treasury 5 years ago, at a rate of 4%. Today a 10-year yields .4%. My treasury still yields 4% right? And so people will pay more for the one I have over the low-yielding ones available from the government today, correct?

Yes, exactly. Bond prices and interest rates have an inverse relationship. Because the interest rates dropped in your example, the value of that bond increased. Had interest rates increased, however, you would need to lower the price of the bond to sell it because no one would be interested in buying that bond when they could go out and buy a new bond with a higher interest rate.
 
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