With $2 trillion in Treasury bonds in tow, the Federal Reserve has a huge impact on the government's fiscal health: the Fed strengthens the government's position while increasing the risk of future increases in interest rates.
Is the Federal Reserve part of the government? You might think so, but you wouldn’t know it from the way we talk about America’s debt. When it comes to the debt held by the public, for example, the Fed is just a member of the public.
That accounting reflects the Fed’s unusual independence from the rest of government. The Fed remits its profits to the U.S. Treasury each year, but is otherwise ignored when thinking about fiscal policy.
In the era of quantitative easing, that accounting warrants a second look. The Fed now owns $2 trillion in Treasury bonds and $1.5 trillion in other financial assets. Those assets, and the way the Fed finances them, could have significant budget implications.
To understand them, we’ve calculated what the federal government’s debt and financial asset positions look like when you combine the regular government with the Federal Reserve, taking care to net out the debt owned by the Fed and Treasury cash deposited at the Fed:
This consolidated view offers five insights about America’s debt situation:
The Fed thus strengthens the government’s net financial position, but increases the fiscal risk of future increases in interest rates. When the Fed buys Treasuries, for example, it replaces long-term debts with very short-term ones, bank deposits. That’s been a profitable trade in recent years, with short-term interest rates near zero. But it means federal coffers will be more exposed to future hikes in short-term interest rates, if and when they occur.
This post was coauthored by Hillel Kipnis, who is interning at the Urban Institute this summer. Earlier posts in this series include: Uncle Sam’s Growing Investment Portfolio and Uncle Sam’s Trillion-Dollar Portfolio Partly Offsets the Public Debt.