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The Federal Reserve Coin and Currency Service Website describes their currency order process thus:

The 7.2 billion notes included in the FY 2015 order reflect the Board’s estimate of net demand for currency from domestic and international customers.

The print order is determined, by denomination, based on historical payments to and receipts from circulation, destruction rates, and also to build inventories of new-design notes before issuance. Historically, most of the notes that the Board orders each year replace unfit currency that Reserve Banks receive from circulation.

The estimated number of notes that Reserve Banks will destroy accounts for nearly 85 percent of the proposed FY 2015 print order and includes both unfit currency, as well as all old-design $100 notes received from circulation. The expected growth of Reserve Bank net payments (payments less receipts) to circulation primarily accounts for the remainder of the notes in the FY 2015 print order.

From this description, it is unclear to me how and when M0 Money is created. It seems this is tied to 'Reserve Bank net payments'.

How and when is M0 money created?

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First it is helpful to provide some definitions.

M0 includes all paper dollars (plus coins and US notes). Regardless of whether or not they they are held in the banking system.

M0 is not a useful metric because it omits electronic dollars. The two main liabilities to the Fed are electronic dollars (some refer to them as Fed Funds or deposits at the Fed which banks can hold) and paper dollars.

M0 + electronic dollars = MB. MB is by far a much better metric for measuring what the government has created for money.

The Fed's balance sheet may be illustrative in showing how this works. Much of the Fed liabilities are MB, but only a much smaller part are M0. The difference between paper and electronic dollars is not significant. If a bank asks the Fed to trade their electronic dollars for paper (or vice versa, the Fed will oblige. If the Fed runs short on paper, they will have the treasury print more, but this doesn't expand MB.

Think of paper dollars as ice, electronic dollars as flowing water and MB as all the water in the system (frozen or flowing). Whatever the form, it is not important as the total amount of water remains the same.

Let's try to answer our question specifically using a timeline and ledger entries.

Say the Fed buys some assets from a bank. They acquire these assets (+Fed assets) and grant the bank new deposits (+liabilites aka bank deposits). Now this is always done with electronic dollars to start.

Then say the bank has a lot of withdrawals and wishes to convert some of their federal despots assets into cash assets. They ask the Fed to do this, which gladly obliges. The Fed decreases their deposit liability and increases their paper note liability. In this moment M0 was increased. But it is not significant. What was significant was when MB was increased after the Fed acquired the asset from the bank.

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    $\begingroup$ Almost all of what you've written obscures your actual answer. $\endgroup$ – EnergyNumbers Nov 24 '15 at 6:47
  • $\begingroup$ It's a complicated question that deserves a complicated answer. M0 is very obscure and only changes in reaction to obscure and unimportant changes in demand for paper or electronic dollars. $\endgroup$ – user2662680 Nov 24 '15 at 14:00
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    $\begingroup$ No, it's a simple question and you've over complicated it and sent the OP down a rabbit-hole. You've answered the question that you think they should have asked, rather than what they did ask $\endgroup$ – EnergyNumbers Nov 24 '15 at 14:38
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Physical Money

M0 is just paper and metal. The paper is printed in D.C. and Fort Worth by the Bureau of Printing and Engraving and banks purchase it using electronic money they have in their federal reserve deposit accounts. Nothing special there and the effective money supply doesn't really change when M0 changes.

How the Fed Increases the Money Supply

What it sounds like you are asking is how the Fed increases the money supply in general. The Fed is constantly buying, selling, lending, and borrowing. It does this through its open market operations desk at the NY fed and through other mechanisms such as lending to banks at the discount window and paying interest on deposits at the fed. At any time you can look at how much money is flowing out of the fed (purchases, loans, and interest) and how much is flowing in (sales, redemptions, and borrowing) and compute the difference. If they are buying and lending more than they are selling and borrowing, the money supply increases. That's how it happens and it is going on continuously. Sometimes they buy things for above their market price (or push the price up) if they are trying to inject a lot of money into the supply or buoy up a particular market.

If the Fed increases the money supply in general, then it is possible that the number of physical dollars in use will increase, which means the Bureau of Printing and Engraving needs to spit out some more paper. This is not that important of a consequence, though. The spitting out of paper is not what increases the money supply. Every physical dollar is purchased with an electronic dollar, so the effective money supply does not change.

Where Fed Dollars Come From

The key to understanding the Fed is to remember that they are the only institution that doesn't really have a budget constraint. When they buy something, they create brand new dollars to do so. When they sell something, the dollars they receive effectively disappear. Every other institution, including the federal government, must actually have dollars to spend or get them via borrowing. Because of this property, every time they buy something or make a loan, the money supply increases.

By the way, the fact that the Fed can make up and destroy money is why it makes little sense to worry about or discuss the Fed's balance sheet. It's the unique institution with the property that its balance sheet doesn't need to affect its behavior.

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  • $\begingroup$ This doesn't really answer the question. The question, whether it is his intention or not, is about M0. $\endgroup$ – jmbejara Aug 6 '17 at 1:08
  • $\begingroup$ Sure it does. My first paragraph says banks buy it from the Fed with electronic money in their reserve accounts. Full stop. If banks want or need more, they buy more. More is printed if the Fed is expanding the money supply and expects more demand for paper money as a result. But printing paper money does not expand the money supply overall because it is purchased with electronic money. $\endgroup$ – farnsy Aug 6 '17 at 1:27
  • $\begingroup$ Actually retail banks also create money through lending . . . $\endgroup$ – Kinnard Hockenhull Aug 7 '17 at 16:52
  • $\begingroup$ @KinnardHockenhull The OP is asking about the Fed's role in creating M0, not about the fractional-reserve banking system in general. $\endgroup$ – farnsy Aug 7 '17 at 17:17
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    $\begingroup$ . . . I am the OP. $\endgroup$ – Kinnard Hockenhull Aug 7 '17 at 17:22

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