Economics, Monetary Policy, Pethokoukis

Why the Fed isn’t yet monetizing US debt

Image Credit: St. Louis Fed

Image Credit: St. Louis Fed

Buying and selling government securities is mostly how the Fed conducts monetary policy. Sometimes it creates money — using it to purchase Treasuries to lower interest rates — and sometimes it destroys money — selling the Treasury debt it owns to raise rates. So, as a new paper from the St. Louis Fed explains, “there is a sense in which the Fed is “monetizing” and “demonetizing” government debt over the course of the typical business cycle.”

But the phrase “monetizing the debt,” when properly used, refers to the Fed’s use of money creation as a permanent source of financing for government spending. So whether the Fed’s actions of recent years amount to monetizing the debt hinges on intent and duration. Is its enlarged balanced sheet a permanent state of affairs or not?

If the recent rapid accumulation of Treasury debt on the Fed’s balance sheet constitutes a permanent acquisition, then the corresponding supply of new money would be expected to remain in the economy (as either cash in circulation or bank reserves) permanently as well. As the interest earned on securities held by the Fed is remitted to the Treasury, the government essentially can borrow and spend this money for free.

If, on the other hand, the recent increase in Fed Treasury debt holdings is only temporary (an unusually large acquisition in response to an unusually large recession), then the public must expect that the monetary base at some point will return to a more normal level (through sales of securities or by letting the securities mature without replacing them). Under this latter scenario, the Fed is not monetizing government debt—it is simply managing the supply of the monetary base in accordance with the goals set by its dual mandate. Some means other than money creation will be needed to finance the Treasury debt returned to the public through open market sales. For the record, Fed Chairman Ben Bernanke has repeatedly propounded this latter view.

And as the above chart shows, “the vast majority (85%) of marketable U.S. Treasury debt is held outside the Fed and is close to the average ratio held over the past 20 years.”

9 thoughts on “Why the Fed isn’t yet monetizing US debt

  1. What a load of crap. It is not intention or duration that determines whether the Fed is monetizing debt per its own definition – it is the act itself and the results that determine whether debt is or has been monetized. The Fed’s actions have been purposefully taken to, among other things, depress interest rates and counteract anticipated deflationary pressure on the dollar following the crash (although in actuality, it was done primarily to restore balance sheets on member banks by transferring bad debt to the taxpayer). One side effect of this behavior has been to cut the carry cost of ballooning federal debt to the US government. As it stands right now, if the Fed were to exit ZIRP, the interest expense on this federal debt would skyrocket, consuming a large fraction of federal tax revenues and worsening the fiscal problem. The Fed has painted itself into a corner from which it will not soon or may never emerge.

  2. The Fed often trots out this argument — that it can rein in inflation before it becomes an issue by charging higher interest on its excess reserves — but it’s been debunked many times. In short, the Fed doesn’t “destroy” money. Once new money is introduced into circulation, banks can lend it out, whereupon other borrowers can deposit it into other banks, which then do the same thing. Thus new money creation grows exponentially thanks to fractional reserve banking — so these QE injections are much larger than meets the eye. Charging interest on the original Fed injection does nothing to “destroy” money.

    And who says the term “monetizing debt” means “permanently” providing government with revenue? If the Fed is expanding its balance sheet by buying U.S. debt that would otherwise be sold to legitimate investors, it is inarguably monetizing debt.

    If anyone is interested in why Bernanke is full of it when he makes similar arguments to those above, Bob Murphy has a useful tutorial here:

    • Fiat money is deciding that money is worth nothing, then trying in vain to change the subject to how much money there is. This is exactly what the 1913 Federal Reserve Act did. The Federal Reserve lives to regulate the money supply, not, as the US Constitution directs, to regulate money’s value. No one at the Fed can say what a dollar is, there is no creation or destruction of money, only destruction of money’s value, destruction of what money is. Fiat money loses value every day it exists because of what it is, no matter what fiat-money-laundering strategy the Fed trots out. The Fed is for putting as much distance as possible between money’s value and the US government. A gold dollar needs no laundering, no big government, no government debt, no entire world revolving around borrowing and lending, puts buying and selling first, makes government the servant instead of the usurper of commerce.

  3. A very poor analysis from somebody who normally doesn’t buy into the official line. There’s absolutely no way to determine intent and duration is irrelevant when you can simply refund the debt. What we know is that the Fed has maintained a large volume (even if the amounts are represented by different numbers) of marketable U.S. Treasury debt, which it has “paid for” using its power to create currency. It has already monetized debt.

    • that he will initial the exiesnton of this contract for 5 more years . However , I would like to add a clause that would start out in case of death , what would you suggest I do , go to a lawyer and write a new contract , or add a clause and have him sign it . Any suggestions would be helpful Thanks Frank

  4. ” money creation ”

    Pure fiction. People decide what money is worth, fiat money isn’t money creation, it’s drastic reduction in what a dollar is worth. Fiat money by definition is robbery, is ignoring money’s value, is not gold.

    ” Some means other than money creation will be needed to finance the Treasury debt ”

    Pure fiction finances nothing, a gold dollar needs no government debt, finances commerce, serves everyone, robs no one, shrinks government wholesale.

  5. Who gets the interest from the bonds and MBS the Fed is buying? My understanding is
    the US Treasury depr does. So how is this not
    monetization of the US federal debt under any
    credible definition of the term. The author of this propaganda piece must not value his credibility.

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