Kenneth R. Szulczyk
The Federal Reserve
Assets Liabilities
- $20,000 Reserves
+$20,000 U.S. Treasury deposits
The U.S. Treasury Department
Assets Liabilities
+$20,000 Deposits at the Fed + $20,000 U.S. T-bill
The U.S. Treasury collects your $20,000 and buys something with it. When the Treasury
pays for a product or service from the public, then the U.S. government pays $20,000 to a
company, and the company deposits the $20,000 into its bank account. Consequently, the U.S.
government returns $20,000 to the economy, causing zero changes in bank reserves. Thus, when
the U.S. Treasury issues new securities, the new securities do not affect the monetary base and
money supply.
If the U.S. Treasury sold government securities directly to the Fed, subsequently, the Fed is
financing budget deficits, called monetizing the debt. Media refers this to printing money. For
example, the Fed directly buys $100,000 in T-bills from the U.S. government. Consequently, we
show the impact on the Fed’s and U.S. Treasury T-accounts below:
The Federal Reserve
Assets Liabilities
+$100,000 T-bills +$100,000 U.S. Treasury deposits
The U.S. Treasury Department
Assets Liabilities
+$100,000 Deposits at the Fed + $100,000 T-bills
The Fed purchasing securities directly from the U.S. Treasury do not increase the monetary
base as long as the money sits into the account. However, once the U.S. Treasury spends the
money in its account, then the Fed’s assets increase, expanding both the monetary base and
money supply.
The Federal Reserve is not required to buy U.S. government securities or help the U.S.
Treasury finance budget deficits. The Fed and U.S. Treasury are independent. However, the Fed
can finance budget deficits indirectly. For instance, if the Fed stabilizes interest rates, then the
Fed could monetize the debt indirectly. For example, the U.S. Treasury issues new securities,
decreasing the securities’ market price and raising the interest rate. If the Fed maintains the
original interest rate, subsequently, the Fed must buy the U.S. government securities to return
the interest rates to the same level.
Central banks are not independent from their finance ministries in developing countries.
Unfortunately, the finance ministry forces the central bank to finance budget deficits. When a