How and Why Is the Fed Creating $1 Trillion?

BY busadmin  March 18, 2009 at 5:57 PM EDT

Question: How and why is the Fed creating $1 trillion in new funds to buy securities?

Paul Solman: They’ve been calling Fed chairman Bernanke “Helicopter Ben” since he told conservative economics icon Milton Friedman, in a speech a few years ago, that Friedman was right in saying a lack of Fed action helped cause the Great Depression. Bernanke also said that he would follow Friedman’s advice if worst came to worst, distributing money as if from a helicopter to keep the economy from stalling for lack of dollars.

Bernanke seems intent on making good on his promise. Today’s announcement of nearly a trillion dollars in new Fed money is a huge move for a man charged with managing inflation. But as we explained in a story last night, the problem in the economy right now is too LITTLE money, not too much.

So the Fed is doing, in spades, what it always does when it tries to juice the economy: It buys Treasury bills, notes, and bonds with the money it creates electronically — the equivalent of minting new dollars. The money the Fed creates — new so-called “reserves” — get deposited in banks to be loaned out.

At least as significant, by buying Treasuries — the government’s IOUs — the Fed drives down their interest rate and thus makes it cheaper for homeowners to buy or refinance. That’s what’s going on right now, and why interest rates fell after the Fed announcement. I wrote about a kinder, gentler bubble last week. The Fed is doing its darnedest to create one.

Editor’s Note: Watch Paul’s piece on where the bailout money comes from: