Kenneth R. Szulczyk
Your Bank
Assets Liabilities
- $10,000 T-bill
+$10,000 Deposit at the Fed
The Fed
Assets Liabilities
+$10,000 T-bill +$10,000 Bank reserves
The Fed buys the T-bill by using a Fed check. When the bank sends the check to the Fed,
the Fed increases the reserves at your bank. A Fed check is not backed by money per se. As the
Fed clears its own check, it adds numbers to a bank’s accounting books. Afterwards, the bank’s
reserves increase and your bank can lend to someone, so the bank earns interest. Consequently,
the Fed’s assets increase while both the monetary base and money supply expand.
For the second example, the Fed buys one T-bill from you for $10,000, using a Fed check.
Subsequently, you deposit the Fed check at your local bank, and your net assets did not change.
Bank’s reserves increase by $10,000, as well as the demand deposit. Finally, the Fed’s T-
account becomes identical to the last example.
You
Assets Liabilities
- $10,000 Treasury Bill
+$10,000 Demand Deposit (Checking)
Your Bank
Assets Liabilities
+$10,000 Fed Reserve Deposit +$10,000 Demand Deposit
The Fed
Assets Liabilities
+$10,000 T-bill +$10,000 Bank reserves
Money supply has risen because you traded the T-bill for a demand deposit. It makes no
difference if the Fed purchased U.S. securities from the public or a bank. Consequently, the
Fed’s assets increase, expanding the monetary base. Your bank’s reserves increase, and your
bank can lend to earn interest. Then the money supply increases. If the Fed sells U.S.
government securities, subsequently, the opposite occurs.
The Fed loans are the second most important asset. The Fed lends to banks, helping the
banks survive liquidity problems. The Fed loans are called discount loans. Furthermore, we call
the interest rate the Fed charges for these loans the discount rate. The Fed does not use loans to
influence the monetary base. Instead, the Fed relies on open-market operations because the Fed