How do the Open Market Operations of US Treasury Bonds by the Fed increase the money supply, i.e. reserves?


I do not fully understand how Open Market Operations of US Treasury Bonds by the Fed increases the money supply, i.e. reserves. Treasury issues a $1000 bond which is given to a primary dealer to auction off. The NY Fed buys that particular bond by crediting the dealer's bank account with $1,000 the Fed just created. But doesn't the dealer now have to remit that $1,000 to Treasury? The dealer is at net $0.00 (ignoring commissions or other minor amounts). So when the Fed buys bonds, the new money actually ends up at Treasury. That doesn't seem to agree at all with my reading that the new money is held as reserves at commercial banks. Can you please clarify?


Money supply increases when the FED (say NY FED) buys T-bonds from other banks (say Wells Fargo) or non-bank public (say a household or a dealer) in a secondary market, NOT a primary market. The Treasury does not get anything if its assets are bought or sold in secondary markets, just as a construction company does not earn any revenue if an old house is sold by its current owner to someone else. Secondary market trade in T-bonds implies just a transfer of ownership (in this case from Wells Fargo or a dealer to NY FED) – the issuer (the Treasury) does not acquire any new funds. Thus, to follow your example, the dealer or Wells Fargo does not remit the $1000 to the Treasury and holds new cash worth $1000.

Last updated on
March 9, 2018

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