Thursday, October 9, 2014

Treasury and Federal Reserve Collusion

-Paul-Martin Foss
Last week, the Brookings Institution held an event entitled “Debt Management in an Era of Quantitative Easing: What Should the Treasury and Fed Do?” Among the speakers at the event was Larry Summers, the former Treasury Secretary who at one time was touted as a possible candidate for the position of Federal Reserve Chairman. Summers, along with three other economists authored a paper in which they argued that the Treasury and Federal Reserve were working at cross purposes during quantitative easing (QE). Summers argued that at least one third of the Fed’s attempt to drive down long-term interest rates was undone by the Treasury’s issuance of more long-term debt.

What Summers and his confrères seem to be overlooking, however, is who benefited from the lowering of interest rates. Any time the Federal Reserve drives down interest rates below the market rate of interest, it cheats creditors and provides a benefit to debtors. And who is the biggest debtor of them all? The US government.

The explicit aim of the Fed’s program of quantitative easing was to drive down long-term interest rates. That aim was announced well in advance, allowing the Treasury to prepare to issue more longer-term bonds and thus lock in lower long-term rates than would otherwise have been feasible. And because big Wall Street banks knew that the Fed would be purchasing trillions of dollars of bonds, they were ready and willing buyers of new long-term Treasury debt that they could immediately turn around and sell to the Fed for a profit.

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