Mint the coin: How can we do that and not increase the debt?
Table of Contents
US government fiscal and monetary policy
Starting after the US Civil War, the US federal government executive branch started getting more powerful. They got even more powerful after passing the New Deal.
Fiscal policy: Adding or subtracting US dollars to/from the economy
The US Treasury became more fiscally independent, which means they had more leeway in figuring out HOW to fund the US government.
But, for various reasons, they lost some control over the macroeconomic affairs/operations of the US government.
Some of the reasons are mandatory spending programs (social security, medicare, etc) and macroeconomic automatic stabilizers such as unemployment insurance.
Some independent agencies (Tennesee Valley Authority for example) were established and given discretionary spending and revenue-generating activities, outside of Treasury operations or control.
The amount of money the US treasury spends into the economy, and taxes out of the economy is determined by the bills passed by Congress. The Treasury does not create money without Congressional authorization.
Having said that, some of those authorizations are perpetual, such as social security and medicare.
And of course, there is the creation of the Federal Reserve, the bank where the banks’ bank.
Monetary policy: Setting and managing to a target interest rate
The Fed mandate includes doing whatever is necessary to manage to a target interest rate, which they set.
They also ensure our commercial banking payment systems run smoothly (has liquidity).
They do this by injecting reserves into and removing reserves from the banking system as needed.
This happens every day and this is part of them hitting their target interest rate, something in which they have been given almost full independence in doing.
Doing this is “monetary policy”.
To serve their mandate to keep the banking payment clearing system running smoothly and to hit that target interest rate, the Fed is constantly injecting and removing banking reserves into and out of the commercial banking system.
Fed monetary operations do not affect our national debt
Starting in 2006, the Fed is authorized to pay interest on reserves and to offer other interest-earning accounts. Something called term deposits.
While term deposits have maturity dates, require interest payments, etc, and in other ways kind of look like treasury bonds, they’re not and they don’t count towards our national debt.
So, there are US government obligations, on which the government pays interest, that is not debt.
So, now we have a situation in which the Fed has obligations to pay interest on term deposits that have maturity dates but do NOT count as debts of the United States, while the Treasury has obligations to pay interest on Treasury bonds which also have maturity dates and DO count as debts of the United States.
The Fed uses treasury bills to manage banking reserves
The Fed and the commercial banks have historically held US debt obligations in the form of treasury bonds, bills, and notes, and used them to inject money into the banking system, as well as to take money out of the banking system.
When a commercial bank needs more reserves, the Fed gives them US dollars and takes away an equivalent amount of their treasury bills. In this instance, the Fed buys treasury bills from the bank.
When a commercial bank has too many reserves, the Fed takes away those excess US dollars and gives them an equivalent amount in treasury bills. In this instance, the Fed sells treasury bills to the bank.
Today, the Fed holds (has bought) all kinds of bad debt
Do you remember “toxic assets” from the 2008 financial crisis? What happened to them?
The Fed bought them from the banks they were bailing out.
In doing so, they transferred the bad debt from the balance sheet of the commercial bank to the balance sheet of the central bank.
Those toxic assets were then left to “rot” on the Fed balance sheet where they may still be for all I know.
One type of those toxic assets, Ginnie Mae’s (a type of mortgage-backed security) which are guaranteed by the US government and therefore count toward the US debt.
Other types of toxic assets, Freddie Mac’s and Fannie Mae’s (other forms of mortgage-backed securities) are NOT guaranteed by the US government and therefore do NOT count towards the US debt, even though the US government has said that in spite of that if banks need them to be bought again in a future bailout, they will be.
In 2020, in response to the Covid pandemic, the Fed has bought other forms of non-federally guaranteed assets (corporate debt, state and local government debt, etc) in order to take ownership of the bad loans and effectively give those other organizations a clean slate.
They bought all this bad debt with US dollars and injected that money into the banking system. Some (I wish I could find out how much) of those extra reserves earn interest, which ARE obligations of the US government but doesn’t count towards the US debt.
The Treasury and the Fed talk to each other
In order for the Fed to buy Treasury securities to a commercial bank, the bank must first have them.
In order for the Fed to sell Treasury securities to a commercial bank, the Fed must first have them.
Where do they come from? The treasury. Whose obligations count towards the US debt and which count towards the debt ceiling.
So, there is a limit to how much the Fed can use treasury securities to manage monetary policy and that limit is the amount of treasuries in existence, which is capped by the debt ceiling.
So the treasury and the Fed talk often and pass treasury bills back and forth (on the “open market” through a network of “primary dealers” as required by law) as needed to ensure they don’t hit a limit that prevents the Fed from being able to provide banking system liquidity and hit their target interest rate.
