Should The Fed Purchase Treasuries Only?

George Selgin has an interesting post discussing the question of whether the Fed should buy only Treasury securities or a cross-section of marketable securities. This issue came up at a recent Cato money conference, where Joe Gagnon suggested the Fed might want its balance sheet to include a relatively comprehensive portfolio of public and private sector assets. George has advocated a similar policy, but also quoted Marvin Goodfriend favoring a “Treasuries only” policy:

When the Fed substitutes an extension of credit for a Treasury security in its portfolio, the Fed can no longer return to the Treasury the interest it had received on the Treasury security that it held. In other words, when the Fed sells a Treasury security to make a loan, it’s as if the Treasury issued new debt to finance the loan. Credit policy executed by the Fed is really debt financed fiscal policy. …

In effect, Fed credit policy works by interposing the United States Treasury between lenders and borrowers in order to improve credit flows. In doing so, however, the Fed essentially makes a fiscal policy decision to put taxpayer funds at risk. In the event of a default, if the collateral is unable to be sold at a price sufficient to restore the initial value of Treasury securities on the Fed’s balance sheet that was used to fund the credit initiative, then the flow of Fed remittances to the Treasury will be smaller after the loan is unwound. The Treasury will have to make up that shortfall somehow, namely, by lowering expenditures, raising current taxes, or borrowing more and raising future taxes to finance increased interest on the debt.

Think of the argument this way. If the Fed buys equities with newly created money, it’s logically equivalent to the Fed buying bonds, giving the bonds back to the Treasury, having the Treasury destroy them, and then having the Treasuring borrow money with newly created bonds in order to buy stocks, and then giving the stocks to the Fed. Do we want the Treasury to borrow money to invest in the stock market?

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Gary Anderson 10 months ago Contributor's comment

Interesting concept, prof. I have wondered why central banks are so reluctant to carry a large balance sheet as does the BOJ. But as you say, central banks in Japan and Europe buy low or negative interest bonds. Is that because they are trying to create more demand for the bonds? Would there be a surplus of bonds if they did not buy, resulting in the need to offer higher yields? Japan seems to between a rock, the need to keep rates low, and a hard place, the need to sell the bonds by offering a better yield.