Printing Money to Counter Deflation in the Great Recession

In my prior post, I described three major tactics that are being used to combat deflation.  Today, we’ll talk more about the printing of money, and how it might actually help stop deflation.  Before we begin, however, let’s take a look at what the chairman of the Federal Reserve has had to say about printing money.  On June 7th, 2009, Ben Bernanke told viewers of 60 Minutes:

You’ve been printing money?” Pelley asked.

“Well, effectively,” Bernanke said. “And we need to do that, because our economy is very weak and inflation is very low. When the economy begins to recover, that will be the time that we need to unwind those programs, raise interest rates, reduce the money supply, and make sure that we have a recovery that does not involve inflation.”

In a follow-up interview on December 5th, 2010, Bernanke said this:

“One myth that’s out there is that what we’re doing is printing money. We’re not printing money. The amount of currency in circulation is not changing. The money supply is not changing in any significant way. What we’re doing is lowing interest rates by buying Treasury securities.”

So which is it?  Is the Fed printing money, or not?  Did Ben Bernanke misspeak, or worse, misrepresent the truth?  Perhaps the Fed was printing money in 2009, but not in 2010?  Or is something else going on?

Before we can answer these questions, we must first define money.  Is money the dollar bills you carry in your wallet?  Is it the money you keep in a checking account at the bank.  Is it the money you keep with your stock broker in a money market account?

Truth of the matter is, all of these are considered forms of money, but not all money is created equal.  In these cases, the money in your wallet is considered M0, the money in your checking account is considered M1, and the money in your money market account is considered M2.  Generally speaking, the larger the M-number, the less liquid and more highly leveraged is the money.

Fractional Reserve Banking, and the Multiplier Effect

In order to understand the relationship between these categories of money, we must first explore the way money is created.  In most of the world, the supply of money is created and controlled through a fractional reserve banking system, coordinated by a central bank.

These central banks can influence the supply of money by printing currency, by lending money into existence, and by changing the reserve requirements for member banks.  It’s called a fractional reserve system, because for every dollar on deposit with a member bank, that bank must retain a fraction of those deposits in their account.

If the reserve requirement is set to 10%, for example, the banks can lend out up to 90% of their deposits.  If a bank does lend out 90% of their deposits, those dollars will land in another bank, who in turn can lend out 90% of that balance.  So on, and so forth, until the original deposit creates money worth many times the original deposit.  This is called the “multiplier effect,” and can be calculated as 1/(reserve requirement).

Leverage, and the Money Supply

If we put all of this together, we can now see the various forms of money, and how they are related to each other.  Consider the following chart:

Components of the Money Supply
M0 Currency $0.9 Trillion
M1 Cash Equivalents $1.8 Trillion
M2 Bank Leveraged Money $8.8 Trillion
M3 Business Leveraged Money $14 Trillion
Unregulated Money
Derivatives $600 Trillion


From this chart, it’s important to know that the Fed can inject money into all of the buckets above.  If they choose to inject money into M0 or M1, they are putting high powered, un-leveraged money (base money) into the system which will be greatly expanded through the multiplier effect.

Now that we have some common reference points, let’s return to Ben Bernanke’s comments, and see what’s been happening to our money supply since the real estate bubble burst, and the Great Recession began:

Chart of U.S. Money Supply Growth

As this chart clearly shows, the most leveraged forms of money started to collapse in 2008, along with the real estate bubble.  To compensate, base money was infused into the system by the Fed.  So, was Ben Bernanke being truthful?  I guess it depends on what your definition of money is.  A strict definition of “printing money” would only involve increasing M0.  Using this definition, Bernanke was correct.  He was printing money in June 2009, but he was not “printing money” in December 2010.

Next time, we’ll continue our discussions about the money supply, deflation and the U.S. Government’s role in printing money.  As always, comments welcomed and encouraged. is a blog by Jay Fenello, principal and founder of, an Atlanta-based
Business Brokerage and Placement firm that helps people buy and sell small businesses and franchises.

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