Everything You Think You Know About The Federal Reserve Is Wrong

by Mark Dow and Michael Sedacca

Few would still argue against the assertion that the Federal Reserve has been central to the financial stabilisation and economic recovery from the 2008 crisis. They fixed the plumbing and are now trying to incentivise animal spirits to pump water through the pipes. The debate has now migrated to exit strategies and whether growing side effects from exceptional monetary accommodation outweigh incremental benefits.

Nonetheless, it is the Fed, views are heated, and many misperceptions persist. The concept of money printing resonates strongly and intuitively with almost everyone, but most of the intuitive reactions to the Fed’s QE are turning out to have been wrong. Here are some of the major ones that linger.

1. Money printing increases the money supply. The Fed does not control the money supply; they control base money (or inside money), which is a small fraction of the broader money supply. In our fractional reserve system, the banks (loosely defined) control the other 90% or so of the money supply (a.k.a. outside money). And the banks have not been lending. This is why the money supply has not grown rapidly in response to years now of QE.

2. QE is “pumping cash into the stock market”. The truth is little of this money finds its way into the stock market.

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