Treasury and Central Bank Interactions
This post concludes our study of central banking matters (there would be a lot more to cover…maybe another time). The post studies how the Fed is involved in fiscal operations and how the U.S. Treasury is involved in monetary-policy operations. The extensive interaction between these two branches of the U.S. government is necessary for fiscal and monetary policies to work properly.
Once again the balance sheet of the Federal Reserve provides a simple starting point. The Treasury holds an account (called Treasury’ General Account, TGA) at the Fed, which is part of L3. To simplify, this post assumes that the Fed still follows the monetary-policy procedures that it followed prior to the 2008 crisis.
By Eric Tymoigne
Previous posts studied the balance sheet of the Fed, definitions and their relation to the balance sheet of the fed, and monetary-policy implementation. This post answers some FAQs about monetary policy and central banking. Each of them can be read independently.
Q1: Does the Fed target/control/set the quantity of reserves and the quantity of money?
The Fed does not set the quantity of reserves and does not control the money supply (M1). It sets the cost of reserves; that is it.
In terms of reserves, the Fed was created to provide an “elastic currency,” i.e. to provide monetary base according to the needs of the economic system in normal and panic times. It would be against this purpose to implement monetary policy by unilaterally setting the monetary base without any regards for the daily needs of the economy system.
By Eric Tymoigne
Yesterday National Public Radio ran a segment on penny hoarders. These are people whose hobby is to hoard pre-1982 pennies. Some even go to their local banks and ask to convert dollar bills into pennies and then spend their evenings triaging boxes of pennies. Why would they do that would you ask? Well, pre-1982 pennies are made mostly of copper and, given the price of a pound of copper tripled over the past ten years, the face value of a penny is half the value of the content of copper: face value is 1 cent, intrinsic value is 2 cents. 100% profit from selling pennies for their copper content!
The new BEA figures about economic activity continue to point to a replay of a Japanese-style lost decade or, even worse, a 1937 scenario. The current expansion has been the weakest on record since World War Two and the trend since the early 1980s does not provide much comfort. Figure 1 shows that each economic expansion since the 1980s has been weaker and weaker and the rate of decline has accelerated.
The current debate in Washington does not provide any comfort for the short run or the long run with both political parties willing to jeopardize whatever economic growth we have left over a fictitious ceiling that serves no economic purpose. All this suffering is supposed to help in the long run because of the good that will come from “reforming” (read “dismantling”) pillars of economic progress like Social Security.
The 2009 Obama “stimulus” is long gone and all levels of government negatively contributing to economic growth. Since the third quarter of 2009, the contribution of the government to economic growth has been nil on average.