MSNBC has released a Q&A regarding liquidity injections into the market, how it works, and what the results of a liquidity injection are.

How does Fed ‘inject’ money into the system?

The Fed operates a trading desk in New York through which is can buy or sell bonds. If it buys bonds, the broker-dealer that sold them gets cash in return. That cash then flows through the system. If the Fed wants to soak up money, it sells bonds from its account — taking cash from the dealer that bought them and taking it out of the system (or “draining” money.) The Fed maintains its own account, so any money being “injected” into the system is not coming directly from the tax dollars collected by the Treasury.

Sometimes, the Fed will restrict these transactions to short-term “repurchase agreements” (or repos) which means the party on the other end of the trade agrees to reverse it after a few days or weeks. This means the shot in the arm is temporary — after the market settles down the money comes back out of the system to avoid pushing inflation higher.

It’s amazing how the market and the country’s economy work. It almost renews my passion for going into business! It’s a great article. If you’re looking to learn the basics of Fed liquidity, check it out. If any of you have other sources (websites, books, articles) dealing with the Fed and the markets drop me a line here. I’m always interested in picking up new material.