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When a central bank increases the money supply, how much of it goes directly into the government purse? Say for example:

  • The money supply is $150

  • The populace has $100

  • The government has $50.

If the Fed decided to increase the money supply to \$200, does any of the extra $50 go into directly into the government purse? Does it vary?

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    $\begingroup$ When you say "increases the money supply" are you talking about monetizing (printing money with no collateral to back it up)? $\endgroup$ – O.M.Y. Dec 14 '15 at 4:48
  • $\begingroup$ @O.M.Y. Yes. Isn't this what the US has done exclusively since Nixon took them off the gold standard? Or is there more to it? $\endgroup$ – Akiva Dec 15 '15 at 3:23
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The answer to this question is maybe (but most likely not).

The most common method central banks use to increase money supply (assuming they control their own monetary policy) is through open market operations. Open market operations is when the central bank purchases or sells treasuries in the secondary market (typically). The answer to your question depends on where the central bank buys the treasuries.

If the central bank uses an open market purchase of treasuries in the secondary market, then the money goes to the entities which sold them the treasuries, so none of the money would go directly to the government. However, hypothetically in some countries where corruption is prominent, there may be a situation where the government forces the central bank to purchase treasuries in the primary market (directly from the government). In this situation, all of the money that is being pumped into the economy would go directly to the government.

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  • $\begingroup$ Good start to an answer. It might be worth noting (in response to the second part of the asker's question) that with respect to the Fed (as with most independent central banks), the answer would be no— the purchases must all be on the open market, intermediated by dealer banks. $\endgroup$ – dismalscience Oct 16 '15 at 19:14
  • $\begingroup$ This answer suffers in a couple of different ways. First, the U.S. is one of the very few countries in the world with a government bond market developed enough to set policy through open market operations. Most use some kind of rate paid on balances held at the central bank as a policy tool. What's more, recently the Fed has had to use interest paid on excess reserve balances (IOER) and reverse repo (RRP) as policy instruments because there is no longer a functioning market in fed funds (excess reserve balances). Any answer to this question should address these two issues. $\endgroup$ – CAMELS Dec 2 '16 at 13:06
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The answer is yes, if the Fed purchases an asset directly from the government. But this rarely happens. I could see it happening in perhaps a convoluted bailout scheme with the treasury department.

A good question would be why not, if so many of the Fed's assets are treasury securities. Wouldn't it be smarter to just cut out the middle man and buy directly from the treasury? I think so, but the Fed fears it would threaten its independence and would be less able to control liquidity in the banking system.

Now the Fed does purchase US notes and US coins from the treasury department using "electronic dollars". When the treasury mints a coin that can actually be thought of something perhaps closer to what your question was asking. The treasury is unique in that the money they create abides by different rules and processes. They don't have to buy securities. When the treasury makes 1 billion in coins, it roughly gave itself 1 billion dollars. They then sell this to the Fed for say 1 billion in electronic dollars (or deposits at the Fed). Largely speaking the treasury only prints US notes and coins as demanded by the Fed so this doesn't effect monetary policy, but this hasn't always been the case.

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  • $\begingroup$ If you're talking about 'why not', you may want to mention that if a central bank buys assets in the primary market, there is no money multiplier. $\endgroup$ – DornerA Nov 24 '15 at 23:22
  • $\begingroup$ I actually think there would be a money multiplier even with primary market purchases. Once the new MB is created to acquire the primary market assets, that MB will have to find its way into the banking system (only banks are allowed to hold deposits at the fed / electronic dollars), and banks with extra MB will multiply it. $\endgroup$ – user2662680 Nov 25 '15 at 2:57
  • $\begingroup$ It the money is spent by the government and is multiplied that way it is considered the government multiplier rather than the money multiplier. It's really just a difference of semantics. It would get multiplied, but not by as much as if the assets were purchased in the secondary market. $\endgroup$ – DornerA Nov 25 '15 at 15:03

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