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Changes in Government Deposits and Money Supply

March 20, 2019

CHANGES IN GOVERNMENT DEPOSITS AND MONEY SUPPLY

The US debt ceiling suspension, signed in February 2018, expires at the beginning of March this year. Some commentators are of the view that the US Treasury must carry out special measures if it expects a delay in raising the debt ceiling in March.

The Treasury would have to draw down its deposits at the Fed and deposit the cash in various government department accounts at commercial banks, for future use to pay government salaries and contractors’ fees.

These commentators are of the view that the Treasury deposit withdrawals act like QE (quantitative easing) and the Treasury deposit build-ups like QT (quantitative tightening). However, is it the case?

If in an economy people hold $10,000 in cash, we would say that the money supply in this economy is $10,000. If some individuals then decided to place $2,000 of their money in demand deposits, the total money supply will still remain $10,000, comprising of $8,000 cash and $2,000 in demand deposits.

Now, if government taxes people by $1,000, this amount of money is then transferred from individual’s demand deposits to the government’s deposits. Conventional thinking would view this as if the money supply fell by $1,000. In reality, however, the $1,000 is now available for government expenditure meaning that money supply is still $10,000, comprising of $8,000 in cash, $1000 in individuals demand deposits and $1,000 in government deposits.

If the government were to withdraw $1000 from its deposit with the Fed and buy goods from individuals then the amount of money will be still $10,000 comprising of $8,000 in cash and $2,000 in individuals demand deposits.

From this we can conclude that a large withdrawal of money from the government deposit account with the Fed is not going to strengthen the money supply as suggested by popular thinking. 

What are the sources for money expansion?

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