OK, call me stupid, but… Are the number of dollars available in our economy fixed? In other words, while an individual might make money…isn’t that just money moved from point A to point B within the economy? Even when we earn interest or sell a share of a stock, the actual dollars are a subset of the total dollars in the economy, right? So, the total dollars available for all of us to get our grubby little hands on is fixed, correct? — except…
Along these lines, aren’t there times when the Federal reserve issues more printed money? And, this is what creates inflation, correct…since every new additional dollar depreciates the total of all dollars out there causing the need to inflate to compensate?
The number of dollars available in the economy is definately not fixed. There are many definitions of money - too numerous/complex to go into here. Every time a bank makes a loan, money is created since it is only required to have a fraction of the money loaned on reserve. The fed attempts to encourage/discourage the amount of bank lending by changing the reserve requirements, the total amount of reserve aggregates, and making it more/less expensive to borrow money from the Fed (discount rate). The fed can also directly change the amount of “money” in the system through buying/selling bonds in the secondary market (open market operations). Typically these open market operations are intended to affect short term rates.
The Fed determines what the expected level of demand for paper currency is and will print money accordingly. If the Fed expects a minor run on banks, it will print more cash to satisfy the demand. This doesn’t necessarily have anything to do with inflation. An increase in paper currency doesn’t necessarily have to affect the amount of liquid monetary aggregates outstanding because the Fed can just increase the bank’s reserves to keep the amount of loanable money the same.
Your first point is correct, most of the time. When you pay interest on a loan, it comes out of your income. When the government pays interest (the return on Treasury notes), it comes out of the budget. In interactions between banks and the Federal Reserve, however, it is possible to add to the money supply (M1). Normally, however, M1 increases when the FR decides to increase it. This is not necessarily inflationary because our population and GDP also increase - as long as the increase in money supply is commensurate with these increases, inflation will not result.