How Money Finds its Way Into the Economy
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President Obama’s stimulus bill is a reminder of how creative our government can be when injecting cash into our economy. However, many are not aware of exactly how and where the money comes and goes. The government does not simply dump billions of dollars into the system and inflation and deflation are some magical by-products — in reality, money is distributed to specific groups at specific times for specific reasons. Today we will examine some of the basic ways that our government puts money into the economy, including some specifics of the recent stimulus package.
The Federal Reserve
It all starts with the Federal Reserve, the “central bank” that literally puts money into circulation at our financial institutions. The banks we use day-to-day (like Bank of America, Wells Fargo, and People’s), may borrow from other banks, but ultimately they borrow from the Federal Reserve – known as simply “the Fed” for short – once it is printed by the US Treasury. As a quasi-public institution, the fed is charged with regulating the nation’s money supply through its setting of monetary policy. Primarily, this consists of setting the interest rates at which banks lend money to other banks, which greatly influences how much money pervades the economy at any given time. When these inter-bank lending rates are too low, many argue, money becomes too easily available and creates economic bubbles.
The Fed reports data on the nation’s money supply weekly and monthly in the form of M1 and M2. M1 is a measure of actual, physical currency, consisting of, “…currency in the hands of the public, travelers checks, demand deposits, and other deposits against which checks can be written” according to the New York Federal Reserve Bank website. This includes currency held by foreigners, as this can, in theory, be spent on US goods. In April 2008, for example, M1 was clocked at $1.4 trillion. M2 consists of everything in M1, “…plus savings accounts, time deposits of under $100,000, and balances in retail money market mutual funds.” M2 was clocked at $7.7 trillion in that same period, the difference consisting largely of savings deposits. The fed typically reports both M1 and M2 data every Thursday at 4:30PM, and you can find the latest stats in Friday business papers like the Wall Street Journal.
The Internal Revenue Service
Outside of physically distributing money, the other main way the government puts money into the economy is by first taking it out of the economy. Before money can be dispersed to particular groups via subsidies, welfare payments, or payments in kind (such as free or subsidized housing), it must be collected from those originally in possession of that money. This is done primarily via income taxation, which represented 44% of all collected taxes in 2006, but also through a number of other taxes including: corporate income tax, gift taxes, employment taxes, excise taxes, and estate taxes. Capital gains (investment income) are taxed as well. In total, it is estimated that the IRS took in $2,518,680,000,000 in taxes during fiscal 2006 according to the Heritage Foundation.
A breakdown of which taxes contributed most to this figure can be found here.
Once collected from taxpayers, this money is then distributed by government to various groups and agencies through vehicles described below.
Subsidies
One of the most common ways government puts money into the economy is through the distribution of subsidies. Any business or industry receiving payments from the government is said to have been subsidized. An oft-cited example is agricultural subsidies, which the government pays to various farmers and corporations deemed (at least ostensibly) to be vital to America’s food supply. A Washington Post investigation into farm subsidies reveals that while most subsidy payments go to farmers growing important crops, as much as $1.6 billion has gone to farmers who grow nothing at all but receive checks anyway due to neglect and systemic fraud. For our purposes, however, we need only know that such subsidies are paid to businesses and industries whose survival is politically important.
Another form of subsidy involves payments in kind, such as subsidized housing. In this case, low-income families are provided with housing paid mostly or in full by the government – that is, taxpayers. The construction and maintenance of subsidized housing puts money into the pockets of contractors, developers, and utilities as well.
Government Contracts
While the government at federal, state, and local levels is responsible for everything from building roads to building schools, government officials do not literally build any of these things. Instead, private firms and individuals are hired to do the work through government bids and contracts. When a town needs a new school or playground, for instance, local contractors and construction companies will typically submit bids of how much they would charge to do the job. The government then selects the winning bid and pays the winner an agreed-upon amount, which then gets spread around to materials distributor, the salaries of those working on the job, and the contractor’s profit.
Government contracts are so potentially lucrative that a website – Business.gov – was established to direct businesses on how to go about submitting bids for them. Between construction, administrative processing and defense, hundreds of billions of dollars are awarded by government contracts every year.
Stimulus Spending
During economic disasters, the federal government typically attempts to “stimulate” the economy by allocating money to sectors or industries in trouble. Perhaps the most famous example of government stimulus spending is the New Deal, enacted by President Franklin Delano Roosevelt between 1933-1935 to offset the crises caused by the Great Depression. The agricultural subsidies discussed earlier actually originated during this time, as farming was hit exceptionally hard by the Depression. In addition, the New Deal sought to right a sinking ship by instituting public works projects. Roosevelt’s Public Works Administration spent some $3.3 billion in taxpayer money paying private companies to build 34,599 projects ranging from dam construction to bridge building, according to Jason Scott Smith’s Building New Deal Liberalism: The Political Economy of Public Works.
A comparable effort to the New Deal is President Barack Obama’s $787 billion Recovery and Reinvestment Act of 2009. The industry deemed most troubled today (as opposed to farming in the 1930’s) is the automotive industry. In order to drive sales in this beleaguered sector, Obama instituted the Cash For Clunkersprogram, which pays individuals $3,500-$4,500 (depending on how fuel-efficient their current vehicle is) to buy a more fuel-efficient vehicle. The program’s website states that Cash For Clunkers is slated to run from July-November 2009 (although this is probably unlikely), and pay over $2 billion to car buyers and that over 250,000 cars have been sold so far, though Edmunds.com notes that interest is reportedly dying down.
MSNBC notes that the stimulus includes a $50 billion “rescue fund” to prevent homeowners from losing their homes to foreclosure. Presumably, these funds are dispersed to the lenders in position to foreclose so that they will not exercise that option.
The stimulus also pumps $40 billion more into expanding payments to the unemployed, $19 billion to food stamps, $3.95 billion for job training, and $125 million for “subsidized community service jobs for older Americans”, according to Wikipedia.
Additionally, some $27.5 billion has been allocated for road and bridge construction, as well as $6.9 billion for public transportation. All of these programs represent money being placed into the hands of various individuals and groups by the government.
So, as we have seen, the ways in which government puts money into the economy are virtually endless. They grow in number every year, and vary according to which way the political winds happen to be blowing at a given time.
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21 Comments so far
leave a commentNot a bad article, but it’s also worth noting that if the money doesn’t come back in to the government coffers, we start seeing inflation. In recent years, we’ve seen government spending going out of control – far in excess of what is expected to come in. That means that tax increases are probably on the horizon which will curb consumer spending because we’ll have less to spend. I think there’s a poster around that shows government spending in a graphical manner and is updated every year. It was pretty neat to see for the first time even though it’s been done for years. The military takes up the vast majority of the government budget and this year our spending exceeds our income by almost 2:1. Makes me long for the day when we had leaders who believed in a balanced budget or the idea that we shouldn’t spend more than we take in.
“The banks we use day-to-day (like Bank of America, Wells Fargo, and People’s), get money in the first place by borrowing it from larger banks, which ultimately get money from the Federal Reserve.”
I think this statement isn’t entirely accurate – because doesn’t Bank of America have access to the fed discount window directly?
Joshua, this is a poorly researched article, you mention interbank lending, yet fail to outline and describe the most insidious inflation moster of them all – Fractional Reserve Banking – that is where most money comes from and why politicians uniformly had us all accept that the GFC was a credit crisis – because it IS – credit means slavery. And Fractional Reserve Banking is to the debtor slavery.
Fractional Reserve Banking is nothing more than the authoritarian, officially endorsed Amway-ponzi scheme/scam we live in on planet earth, too bad if you are not ‘up level’
There are a couple of items missing.
First I’m thinking about the money spend on salaries of gorvernmental or casi governmental administrations employees and their direct expenses: US postal, education departments, the President and his White House, the Congress, the army. This is a way to inject money directly at the local/consumer level for the government.
Taxes are not the only way to remove money from the economy. For short term easing for example are the municipal and state bonds. Although they are paid back in the future with additional dividends they enable to remove temporary stagnating liquidity. The government can also sell it’s assets like federal lands.
For inflation… Well in the US there is a glut of consumer goods and a glut of currency. Both are over valued. So while local inflation is an important question, the larger problem will be the currency exchange rate that become less and less realistic. But then currency speculators and politics keep it far from a natural balance and increase the risk of big swings in the future.
“In total, it is estimated that the IRS took in $2,518,680,000,000 in taxes during fiscal 2006 according to the Heritage Foundation.”
We all know the IRS takes a lot of our money, but I’m pretty sure it’s not 2.5 quadrillion!
The original number is correct. $2,518,680,000,000 is 2.5 trillion which is correct, not $2,518,680,000 which is 2.5 billion.
The fed is lender of last resort, so I’d guess Bank of America has to try to go to other banks before it goes to the fed…
Great article!
Except… I wish people would stop calling the Federal Reserve corporation a “quasi-public” institution. Perhaps “faux public” would be closer to accuracy.
The Federal Reserve is no more “federal” than Federal Express. It is a private corporation, owned by its shareholders, many of them foreign, to which Congress has unconstitutionally granted the very franchise for issuing our nation’s currency.
There’s a reason based in history that Congress was explicitly prohibited from delegating the issuance of currency as it has been doing with the Federal Reserve corporation. America has had a central bank twice before, and absolutely every time, it has been a monetary disaster.
The so-called “Federal Reserve” is not federal, nor does it contain any reserves. Its very name is, basically, a deception.
@Peter and others
There are no government “coffers.”
All* money in circulation represents a debt owed to the Federal Reserve corporation, because the Fed issues from thin air the currency which is used to “buy” government bonds. These bonds must be “paid back” and with interest!
So get this: We are paying interest in the form of taxes on every dollar in circulation.
And really get this: Because of the system we have now, if it were somehow possible for all debts everywhere to be simultaneously repaid, there would be zero dollars in circulation and we would have the ultimate economic implosion.
It would be a catastrophic “de-leveraging” causing the money supply to shrink, destroying the economy.
Sound familiar? It should!!
–
* The unmentionably rare exceptions to the rule of all USA money being nothing more than Federal Reserve debt include any silver or gold currency certificates which may still be circulating, and any Kennedy dollars which were issued directly from the Treasury. However I’m guessing that if you actually tried to redeem a silver or a gold certificate for the precious metal it once represented, that you would not be successful in such an attempt. So basically, those metal certificates aren’t anything at all. But to its holder, a meaningless piece of paper is still preferable to a piece of paper which represents a debt.
One does not have to be an economist to reason what is likely to happen in the very
near future. If a fiat central banking system (the Federal Reserve) continues to ‘print’
more money, from which the government and banks borrow; if taxes increase, making
it difficult for consumer spending to get better (70% of GNP); if the U.S. continues to be
indebted to China; if we are facing another bursting bubble (commercial & industrial
real estate loans); if double digit unemployment continues through 2010; if large banks
continue to not lend to customers; and finally, IF the H1N1 Swine Flu poses even a modest threat to the global society at large beginning in the fall, then I ask the experts: Bernanke, Summers, Geitner et al., where indeed are the “green shoots” and the positive signs of economic recovery?
I am an optimist, because historically America has always been able to return to
prosperity out of fiscal crisis; however, I am also a realist. This festering, convoluted money supply debacle is about to slap us very hard in the face, in my humble opinion.
As an individual or a government, one cannot go on borrowing excessively.
Sooner or later, the piper must be paid.
Politically speaking, between the last seven Administrations and 535 Federal legislators this once great nation has been dragged down to where we find ourselves today. Failed decision-making, ineptitude, corruption, sex scandals, incestuous lobbying practices and greed, pervade all of Washington, D.C.
This is, needless to say, no way to manage a democratic government. We, the people of the United States of America, should demand better. We work hard. We deserve better than the insults to our intelligence, that emanate from politicians, the elites and above all, the MSM.
It is time to re-read the first four paragraphs of the Declaration of Independence and
to revisit the Constitution. It seems apparent that a 21st Century American Revolution
is at hand. We hope it will be peaceful.
you’d think we all the advanced computer systems and technology, we’d know exactly where all the money is at, and make it public.
Couple of notes:
“Primarily, this consists of setting the interest rates at which banks lend money to other banks”
Deceptive because the Fed doesn’t set this rate. They do try to influence it to a target level using the open market and other mechanisms, but they don’t set it and many overnight loans don’t equal the Fed Funds Rate.
“M1 is a measure of actual, physical currency,”
Not entirely accurate. If anything M0 is closer to that definition but most of M0 exists in virtual form as opposed actual physical currency.
“Outside of physically distributing money, the other main way the government puts money into the economy is by first taking it out of the economy.”
The Fed actually never takes money out of the economy. Tax proceeds are deposited into private banks via the Treasury Tax and Loan (TT&L) Service. The Fed does this because they are worried about the affect of withdrawing so much M0 from the economy, so this way the money keeps getting used and inflated to M1 and above levels. That’s the theory anyway, but the TTL program is in essence corporate welfare from the government to the banking industry in which banks receive below market interest rate deposits/loans.
For a full account of how the Fed pumps money into the economy (and why), read “The Creature from Jekyll Island” by G. Edward Griffin.
http://www.amazon.com/Creature-Jekyll-Island-Federal-Reserve/dp/0912986212
I like Peter’s comment. The Federal Reserve IS the cause of inflation. I personally think it should be abolished ASAP.
“Makes me long for the day when we had leaders who believed in a balanced budget or the idea that we shouldn’t spend more than we take in.”
Right on Peter. I’m hoping that the tide will shift towards this mindset. It will be a tough battle to get politicians in who believe in this, but there is at least a few who do right now.
This article is missing quite a few, very important facts about how the Fed actually increases and decreases the money supply and how those increases and decreases actually create and remove the supply of money based on the marginal propensity of the receiver to consume or save those funds.
why is the paragraph on Cash for Clunkers so outdated?
Just a quick follow-up to Reggie’s comment. I agree completely that a complete freeze of money moving from place to place will cause a horrible implosion, but I see that coming if taxes keep increasing. As things stand right now, we’re finally seeing people paying off their debts and getting more and more out of debt and back into more sound personal money-management practices. However, if taxes go up and we are forced to pay more to provide “essential” services, the money will freeze as people stop buying anything except the essentials and work on cutting down those essentials as much as possible which will lead to less money circulating which will lead to more unemployment, more need to provide services, higher taxes, more money not circulating, etc.
I can’t remember who said this, but for all of the evils of capitalism (and there are some), when is the last time any of you got a job from a poor man?
I do appreciate the high-level overview of this article, but it was missing a lot of information and didn’t concentrate on the negative side of government increasing spending. It may help get some industries going, but sometimes I’d say it’s just as fair to let those same industries bail themselves out. The auto industry wasn’t too big to fail, nor was the housing industry. I think a point could be made that if we had let them fail something better or stronger would have taken its place. (Possibly a painful short-term, but if the businesses are failing and we reward them, what do we actually gain?)
dont forget the credit card companies who if u look hard enough u will see are ripping u off big time. dont bother asking any govt agency for help because they are behind it. get rid of those cards folks. dont know how to else to tell u. baaaad news
This is very useful information, especially given the economic crisis! I really think that more economics needs to be taught to students at a younger age (high school?)
While I am not one of those who believe that the Fed is a secret manipulator of our (the world) economy, I believe Mr.McFarland’s view of the roll of government, the Fed and ‘money’ is quaint, and reflects a fiction that is constantly used to mislead the public. As a ’soverign entity’, the government does not need to collect money (taxation, etc) to meet its disbursements. The purpose of the IRS (taxation) is NOT a source of revenues, but is rather to retrieve sufficient quantities of PREVIOUSLY created money to modulate domestic inflation (and ensuing economic disruption & political unrest) and to re-distribute accumulated sums & ‘re-cycle’ it back into the economy (appease the envy of the less-wealthy & avoid evolution economic entities that might eventually challenge the government’s primacy). The purpose of the tax code is NOT so much to specify the manner in which the gov’t will collect taxes as it is to subtly manipulate the economic decisions and behavior of the citizenry without having to issue overt ‘commands’ (ie, avoid the appearance of a centrally planned, totalitarian regieme). The discussion of m0-m3 ‘kinds’ and ‘flows’ of money, and the arcane transactions between the Fed and Treasury, are nothing but recast analogies from the days of the French physiocrats; they are attempts to (induce the public to) reason by analogy -always a useful way to mislead your audience but never a path to real understanding. Mr. McFarland’s ‘explanation’ is nothing but entrenched mythology and does not really explain what is really going on – in this country or (eventually) the world. In this case, if you ‘follow the money’ you are sorely misled.
AudioBooks, don’t you mean 2.5 Kazillion?