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I'm not sure if this is the right site to ask this question. If it's not, please point me in the right direction.

So, if the FED is the only institution that can increase the monetary base (create both, digital and paper money), how can any institution that borrows from it (mostly banks) satisfy its interest requirements? In other words, how can you pay back more than what left the FED?

A dumbed down example would be: Only I can create money, I (the FED) loan you (the banks) $10 expecting $11 back ($10 principal + $1 interest). Where will you get that $1 from to pay me the interest if there are only $10 in existence?

This question can be easily answered if there were any way in which new money can leave the FED without being paid back. Are there such transactions I don't know about?

closed as off-topic by Chris W. Rea, Ganesh Sittampalam, keshlam, ChrisInEdmonton, Dheer Apr 8 '15 at 3:28

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  • "Questions on economics are off-topic unless they relate directly to personal finance." – Chris W. Rea, Ganesh Sittampalam, ChrisInEdmonton, Dheer
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    I'm pretty sure the fractional reserve system means that any bank can increase the money supply to the degree that it has reserves. – David Rice Apr 7 '15 at 19:00
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    @DavidRice Banks can increase the money supply but not the monetary base. They are not the same. – AxiomaticNexus Apr 7 '15 at 19:55
  • This question is off-topic here. Voting to close. Consider economics.stackexchange.com – Chris W. Rea Apr 7 '15 at 20:32
  • Economics, not Personal Finance – keshlam Apr 7 '15 at 22:43
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The money created by the Federal government is spent on public programs increasing the wealth of the general population.

Banks loan money to the general population and make back more money in interests, thus gaining a part of the increased money created by the government. The bank can now pay back more that what the borrowed from the government.

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Banks use the money for productive pursuits, earning returns in excess of what they will owe the fed in discount interest.

If a bank could not yield a return greater than their interest due their lender (whether that lender is the fed or not) they probably wouldn't borrow in the first place.

EDIT: I misunderstood the question. The federal reserve does not disseminate new money by making loans. They do so by issuing and trading in bonds. The US Treasury, for example, issues a bond. The Federal Reserve Bank buys this bond using money they "printed".

So the same question applies.... where does the money come from to pay the interest on the bond? It comes from the perpetual issuance and trading in bonds at a growing rate. All the fed needs to do is to buy bonds at a rate faster than they collect interest.

  • The question is more technical than that. If every dollar that leaves the FED leaves with an interest cost, where is the money to pay that interest coming from? A simplified example would be: Only I can create money, I loan you $10 expecting $11 back ($10 principal + $1 interest). Where will you get that $1 from to pay me the interest if there are only $10 in existence? – AxiomaticNexus Apr 7 '15 at 19:53
  • The fed disseminates money by issuing and buying bonds, not via loans. – Matthew Apr 7 '15 at 19:58
  • Bonds have interest costs to them. – AxiomaticNexus Apr 7 '15 at 20:00
  • Your edit still doesn't mathematically explain how the interest can be fully paid back. By your explanation, yes, the bank can partially pay it, but only with more borrowed money. I don't think I fully understand. – AxiomaticNexus Apr 7 '15 at 20:09
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    @YasmaniLlanes No, there wouldn't. The Fed doesn't issue their own bonds, they issue on behalf of the Treasury. Such bonds can be bought and sold by people other than the fed and create different monetary horizons. Not all bonds can be paid simultaneously, not even the principle. That is, indeed, their purpose. – Matthew Apr 7 '15 at 21:31
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If the question is where banks get the money used to pay interest they owe: they do so by lending that money to us at a higher interest rate. They make a gross profit from the interest we pay, they pass part of that to their depositors as interest, part of it goes to service their own debts, part of it may go to stockholders as dividends, and the rest is net profit.

  • No. The question in a nutshell is how can the FED receive more money in interest than it gives out into the economy. – AxiomaticNexus Apr 7 '15 at 21:34
  • The same way any bank does. Yes, doing so results in money going out of circulation and back to the government. Taxes do the same thing.Most of that money, either way, goes right back into circulation when the government pays for goods, services, and interest on its own loans. Some may stay out of circulation, decreasing money supply; that's one of the ways a government balances between inflation and deflation. But that's an economy question, offtopic here. – keshlam Apr 7 '15 at 22:41

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