Kenneth R. Szulczyk
Total Liabilities = Monetary base (B) + U.S. Treasury deposits + Foreign and other deposits +
DACI + Capital (4)Subsequently, we use the accounting identity as defined by Equation 5 to relate the Fed’s
assets, liabilities, and capital.
Total Assets = Total Liabilities + Capital (5)Finally, we substitute the total assets and total liabilities into the accounting identity, and we
solve for the monetary base, which becomes Equation 6:
Monetary base (B) = U.S. gov. securities + discount loans + gold certificates + SDRs +( CIPC – DACI ) – U.S. Treasury deposits – Foreign and other deposits – Capital (6)Equation 6 shows how a change in the Fed’s balance sheet affects the monetary base. For
instance, if the Fed purchases an asset, then the monetary base increases and expands the bank
reserves. When banks have more reserves, they grant more loans, potentially increasing the
money supply. Of course, the opposite could occur. If the Fed sells an asset, subsequently, both
the monetary base and bank reserves drop, and money supply potentially shrinks. Moreover, if
the Fed acquires a liability in Equation 6, then the monetary base, bank reserves, and the money
supply all fall. On the other hand, if the Fed reduces a liability, subsequently, both the monetary
base and bank reserves rise, and the money supply potentially increases.
Consequently, many things alter the Fed’s balance sheet. Unfortunately, the Fed cannot
control many items on its balance sheet. For example, the Fed has no control over the Treasury
deposits, the float (CIPC - DACI), gold certificates, SDRs, and foreign government deposits. As
these items can change, the Fed must use open-market operations to maintain a stable monetary
base.
Does U.S. Treasury Affect the Monetary Base?
The U.S. federal government has experienced persistent budget deficits for the last 40 years
because the U.S. government spends more than what it collects in taxes. Government finances
budget deficits in three ways. First, the U.S. government can decrease its spending, which is not
politically popular. People demand benefits and social programs from their government. Second,
the U.S. government can raise taxes, which could anger the taxpayers. Finally, the U.S. can sell
U.S. government securities. Thus, the U.S. government chose to finance budget deficits by
selling more U.S. government securities.
Could the U.S. federal government affect the monetary base by financing budget deficits?
For example, the U.S. government increases taxes; you pay a total of $2,000 in taxes, and you