The Treasury & Fed Disagree
August 2, 2012
According to J.P. Morgan’s Economic Research Note, fiscal policy and monetary policy in the US are driven by individual separate goals and work independently.
The Fed conducts monetary policy, Congress and the president decide fiscal policy, and neither side interferes with the other. It is for this reason that when testifying before Congress, Chairman Bernanke avoids recommending specific tax and spending policies, in spite of lawmaker prodding to do so.
The research stated that the Fed tries to lower long-term interest rates by purchasing long-duration assets thus pushing up prices and thus lowering yield. By doing this, it tries to spur growth in aggregate demand. However, the Treasury’s Office of Debt Management (ODM) which determines the pattern of issuance for Treasury securities has an objective of decreasing the cost of borrowing of the Government. Thus, while the Fed tries to reduce the availability of long-duration assets in the market, ODM tries to increase its supply seeing a shortage, as financing costs of these assets will be lower for the ODM.
If the Treasury takes advantage of the richening of the long end to issue more longer-duration securities it will be offsetting much of the easing the Fed seeks to achieve with its balance sheet policies. In fact, over the past few years the Treasury has increased the average maturity of marketable debt by about 10 months relative to before the recession. The amount of duration this increase in the average maturity has added to the market—around $900 billion in 10-year equivalents—is a little more than the amount taken out by the Fed’s QE2 and Operation Twist combined.
Thus, this contradictory approach has a significant cancelling effect on the Fed’s monetary actions.
An honest accounting of the pluses and minuses of such policy should note that there are some interactions with fiscal policy that may have partly blunted the degree to which it has supported the recovery. And when interest rates are at their zero lower bound, the Fed and the Treasury may have to fish from the same side of the lake.
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