Creating Money

There are several ways the Federal Reserve can print money. The federal government cannot print money, though they are often accused of doing so. This blog will discuss the implications of how money is printed.
In 2008, the federal government (and by this I mean the President's office and Congress) ran a $1 trillion deficit. This means they spent $1 Trillion that they didn't have. This doesn't mean that they printed $1 trillion. To pay for the deficit the government goes to the Treasury and asks them to print $1 trillion in bonds. The government then has to sell the bonds in exchange for cash to pay for the $1 trillion deficit. Remember, though, that cash used to pay for bonds is already in existence. The government is taking money from one group of people and giving it to another group of people. The monetary base does not grow.
The Federal Reserve can print money and this done in several different ways. What most people think of when they hear that the Federal Reserve is printing money is actually called "monetizing the debt." This occurs when the Federal Reserve prints cash and pays for the bonds the government printed to fund their deficit.
The Federal Reserve can also print money in other ways as well. They can utilize OMO's (Open Market Operations) to print money. This occurs when the Federal Reserve buys bonds from private dealers (banks, hedge funds, etc.). A multiplier effect occurs when OMO's are utilized. Another way the Federal Reserve can create money is by lowering the Reserve Requirement. When the average person deposits money into a bank, the bank profits from the deposit by loaning the money to other people. However, to ensure safety for depositors, banks can only loan a certain amount of the deposit, usually about 80%. The remaining 20% is the reserve requirement and is fairly innefficient because it just sits in the bank constricting supply of loans thus raising the price of loans.
To put these in perspective of the current recession, I have accumulated some of the stats for what has occurred to the money supply over the last several months. Only about $35 Billion have been monetized. Currently, the Fed will escalate these purchases until they reach $350 Billion. The Reserve requirement has been unchanged since the beginning of the recession. The most interesting money creation that has occurred over that last year has been the OMO's that have occurred. The Fed's balance sheet has expanded from $800 Billion to over $2 Trillion dollars. Initially, the Fed offset all purchases of private bonds (they purchased bonds from private companies like Lehman Brothers) by selling an equivalent amount of short term government bonds. Once they realized that the credit markets had siezed up, they began expanding the balance sheet (which expands the money supply) by purchasing bonds from private banks. This added money and therefore liquidity to banks, allowing them to loan more money to borrowers in an attempt to stimulate the economy. Inflation is almost sure to follow if the economy recovers before the Fed has time to unwind the purchases from the OMO's.