Wednesday, February 24, 2010

Quantitative Unease: The Treasury Assists the Fed in Conducting Monetary Policy

Yesterday the Treasury announced that it would begin auctioning, starting today, $200 billion of Treasury bills in eight weekly auctions.  The proceeds are to be put in a special account at the Fed, the Supplementary Financing Account.  This is a signal, in addition to the recent discount rate increase, that the Fed is beginning to tighten.  What is unusual is that the signal came in the form of a low key Treasury press release.

The Treasury bills being issued pursuant to this program add to the supply of an outstanding issue, that is, the bills being sold at these special auctions have a maturity date that is the same as an outstanding bill issue and will consequently have the same CUSIP number as the outstanding bill issue.  Once issued, there is no way to distinguish this addition to the supply of the outstanding bill to that which was previously issued.

The Treasury had let the supplementary financing account run down to $5 billion because of the debt limit.  It says it is restoring it to the level it was at during much of last year.

The more important point is, as I have written before, the Treasury is undertaking these sales to help the Fed drain reserves from the banking system.   In essence, rather than the Fed selling Treasury securities from its portfolio and thus draining reserves, the Treasury sells newly created securities and the proceeds are taken out of the banking system.  The result on reserves is the same in either case.

Chairman Bernanke said last July that “although the Treasury’s operations are helpful, to protect the independence of monetary policy, we must take care to ensure that we can achieve our policy objectives without reliance on the Treasury.”  The operational benefits of a little more reliance seems to outweigh for the time being the need to protect independence.

According to a Bloomberg News article today (not yet available online), the Fed is trying to downplay the significance of the Treasury announcement.  The article by Rebecca Christie quotes the Fed: “‘The SFP is not a necessary element in the Federal Reserve’s set of tools to achieve an appropriate monetary policystance in the future,’ the Fed said.  ‘Still, any amount outstanding under the SFP will result in a corresponding decrease in the quantity of reserves in the banking system,which could be helpful in the Federal Reserve's conduct of policy.’”

As I have commented in previous posts, there are policy and legal questions one can raise about the Supplementary Financing Program.  The Treasury could also be criticized for paying interest for borrowing money it does not need.  Fortunately for Treasury, short-term interest rates are quite low; the interest rate on the 56-day bill auctioned today was 0.1%.  One can also explain that Fed alternatives would also cost the Treasury money.  If the Fed sold securities from its portfolio, the Fed would receive less interest income and therefore would have less earnings to turn over to the Treasury.  Alternatively, if the Fed raised the interest it pays on excess reserves held by banks pursuant to the authority it received in the TARP legislation, in order to encourage banks to hold idle balances, this would also reduce Fed earnings.

The Treasury also appears to be helping out the Fed in its cash management practices.  It used to be that the Treasury would target a relatively small balance at the Fed, perhaps $5 billion or so, and keep the rest of its cash in commercial banks in what are called Treasury Tax and Loan Accounts (“TT&L”).  A quick glance at Monday’s Daily Treasury Statement indicates that this is not the practice.  On Monday, Treasury held $32.6 billion at its operating account at the Fed, $5 billion in the Supplementary Financing Program account, and $1.9 billion in TT&L accounts.

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