Is the Federal Reserve issuing money in a fair way?

Question

Basic logic says that, once a central bank is issuing new money for increasing the money supply, the money should be distributed fairly between all the citizens, and that means giving them all an amount equal in proportion to their income (say a 5% of their annual income for achieving a 5% inflation). So they should give the money to the government, and then the government either distributes the money or it builds public infrastructure that everyone benefits from. Most likely, this is the way the Eastern European countries experienced inflation in the 1990's.

Conversely, when the Fed decides to remove a certain amount of money from the economy, the Government should tax everyone in a fair way (the rich should pay more than the poor) and then give the money to the Fed to burn it. Or to burn it directly, without even giving it to the Fed.

Instead, the Federal Reserve has some sophisticated and arcane ways to move the money, beyond the comprehension of the general public. The Fed and the banks are involved into actually owning those newly issued money, and that looks really strange.

This article says:

When the Fed wants to expand the money supply, it buys a security -- let's call it Asset A -- from a bank. Then it electronically transfers money to that bank.

Therefore, if the Federal Reserve decides, it can issue new money and buy and own half of the assets in the USA for free whenever they want. The newly issued money get to the banks, and depending on the decision of the banks to use the money or not, they can create inflation - or not. They can give those money in astronomical bonuses to their top executives and those people can send the money to Switzerland for example - therefore no inflation.

Is there something important that I'm missing?

Answer 1

The Fed introduces money in the economy through the banks via the mechanism of fractional-reserve banking, as you mentioned in your article. This means the Fed is then allowing the banks to provide credit to anyone who they find adequate. The reason to do so is that banks will favor investment opportunities which lead to long term growth, such as build a house or a factory, rather than immediate consumption of goods, which would lead faster to inflation. The alternative would be to transfer the money to the government, which would distribute it through investments (like build roads) or subsidies.

Your question is on fairness: whilst there would be several ways to look at what "fairness" means (give the same to everyone OR give more to the ones who deserve/need more), the key point is that the Fed's job is to make the US dollar stable, and not to work on individual bank gains. You can read on the Fed's mission:

(...) to foster the stability, integrity, and efficiency of the nation's monetary, financial, and payment systems so as to promote optimal macroeconomic performance

Their approach to distributing the money is to keep the inflation low, which according to them and the US Congress, is on the best interest of the whole country and not just the banks.

Answer 2

Normative questions require a standard of fairness in order to then be analyzed and answered with some degree of "objectiveness" so that the answer is not just a declaration of philosophical-ideological positions.

The OP starts by writing

"Basic logic says that, once a central bank is issuing new money for increasing the money supply, the money should be distributed equally between all the citizens."

Why "basic logic" says that? Whose "basic logic"? I note that throughout human history and especially in the western civilization in the last 400 years, "fairness" is almost exclusively interpreted as "proportionality", not flat equality (i.e. as "per capita tax" is considered not in accord with current societal values, so are "per capita transfers").

Anyway, under the given fairness standard, certainly "new money is not fairly distributed".

Regarding how the creation of new money works, and how it affects the domestic or global economy (or not), which is an additional question, I believe there are many threads here that provide a lot of information on the matter. Selecting the tag "inflation" or "money supply" will bring up most of them.

Answer 3

No, because monetary policy is known to increase inequality.

In effect, evidence indicates that monetary policy has contributed toward higher inequality. Therefore, the Fed is not being very supportive of fairness, from this point of view.

Reasons are several. Some examples:

• Booming Stock Markets: low interest rates generate booming stock markets. Because shares are mainly owned by the rich, this benefits them proportionally more than the poor:

• Better access to finance by the rich: because of higher collateral, more wealthy individuals have better access to financial markets, including loans to business and housing. Therefore, they benefit much more than the rest of individuals from cheap credit via low interest rates. As this article states:

the wealthier you are, the more you are likely to borrow (until one gets very, very wealthy), because banks will lend you more and because you are likely to buy an expensive house and want to milk the tax advantages of a large mortgage. With today’s low interest rates, a wealthy family with a \$300,000 mortgage could be saving \$7,500 per year in mortgage interest or over \$600 per month. Some wealthy families have much bigger mortgages than that, so the Fed-driven savings to the wealthy could be even larger. Since the wealthy save more from low interest rates than the poor, the Fed’s interest rate policy is making wealth inequality worse.

Some people however say that the activity of the Fed, even if it has increased inequality by the above channels, it remains overall beneficial by fostering higher employment and avoiding a more deep financial and economic recession. Thus, higher inequality is simply a "short-term" cost of the necessary activity of the Fed.

Answer 4

Is there something important that I'm missing?

I think the basics are missing and not just from you but the public in general which is why it' s sounds so complicated. Lets start with the four types of money issued in the United States:

1. Coins - physical money created and issued by the U.S. Treasury and sold at face value to the Federal Reserve, which books coins as an asset on its balance sheet. Unlike the other three forms of money I will outline in this answer, coins are issued without any corresponding debt attached to them. Coins are legal tender, meaning that they can be used to pay, "all debts, public charges, taxes, and dues." 31 U.S.C. § 5103.
2. Cash - aka, Federal Reserve Notes, is physical money issued by the Federal Reserve (though created by the Treasury's Bureau of Engraving and Printing at the Fed's instruction) and sold by the Fed at face value to commercial banks, which pay for cash using their reserve accounts at the Fed, which get debited in the amount of cash obtained. Cash is one of two liabilities on the Federal Reserve's balance sheet, and an obligation of the U.S. government. Cash is legal tender, meaning it can be used to pay, "all debts, public charges, taxes, and dues." 31 U.S.C. § 5103.
3. Reserves - this is electronic money created and issued by the Federal Reserve in exchange for U.S. government bonds and bills, that is, IOUs from the U.S. government. Reserves are the second liability on the Federal Reserve's balance sheet, but reserves are assets to commercial banks and other entities that bank with the Fed, including the U.S. government and foreign central banks. Reserves, that is, Fed liabilities or IOUs, are money only for these entities, and exist only as the result of government debt. The amount of reserves in the system is controlled by the Federal Reserve, which increases reserves by buying government bonds or agency mortgage-backed securities and decreases reserves by selling government bonds or agency mortgage-backed securities. Reserves are not legal tender.
4. Bank money - this electronic money created and issued by commercial banks in exchange for debt, public or private, taken by borrowers from the bank, whose electronic accounts at the bank are credited in the amount of their new loan. Bank money is a liability to commercial banks but is an asset to non-bank entities who bank at commercial banks, including people, non-financial businesses, non-bank financial businesses, and governments...bank money, that is, a commercial bank liability or IOU is money for these entities. The amount of bank money in the system is controlled by commercial banks, which increase bank money bu buying debt, crediting bank accounts in exchange for loan paper, and decrease bank money by not issuing new debt as old debt gets paid off. Bank money is not legal tender.

I think what is confusing and it was even for me, is all the discussion that we hear in the media, but none of the clarification. That discussion is on reserves. Reserves function as money for commercial banks, which have accounts at the Fed, but do not function as money for ordinary people and non-bank businesses, who do not have accounts at the Fed. For ordinary people and non-bank businesses, money isn't reserves, it's bank money. Cash is an altogether different animal for the purposes of this discussion, which pertains to digital money only. But the Fed cannot and does not create bank money. Commercial banks create bank money.

For commercial banks, reserves are asset-money, and bank money, that is, ordinary checking and savings accounts, is liability money. Makes sense so far?

So when the Fed buys assets from a commercial bank or the U.S. government, it creates new reserves and credits in the bank's or the government's Fed account in the amount of those new reserves, and the seller transfer the asset to the Fed in exchange. The key takeaway here is that this simple two-party transaction structure results in an increase in reserves, but no net increase in bank money. The reason there is no change in bank money under the Fed's normal asset purchase route is that there is no non-bank entity, and thus no bank money, involved in the transaction, which is simply a two-party transaction between the Fed and a Fed account holder, a commercial bank or the government, conducted entirely in reserves.

With all that said, the traditional two-party asset purchase structure was recently abandoned by the Fed in February of 2020, however, replaced by a three-party asset purchase structure of getting public money into private hands. Since then what we have been seeing is the lockstep increase in both reserves and bank money.