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eco403-ppt.pptxMacroeconomics
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The Key Issues Addressed in the Paper
How the Federal Reserve System and the Treasury Relate;
The Pre-Crisis Cash Management;
Cash Management by Treasury Following the Onset of the Crisis; and
The Treatment of the Financial Crisis.
How the Federal Reserve System and the Treasury Relate
The U.S. Treasury channels a good part of its receipts the TGA;
It disburses the payments made into the same account;
This ensures a continuous fund flows from the depository institutions to TGA and back again;
The interface required joint management between Treasury and Fed during the crisis
How the Federal Reserve System and the Treasury Relate
There are a number of ways in which the roles of the Treasury and the Fed relate even though they may seem sufficiently distinct. The U.S. Treasury channels a good part of its receipts the TGA (Adrian, 2009). Similarly, it disburses the payments made into the same account. This ensures that there is always continuity in fund flows from the depository institutions to this account and back again. This continuous flow of funds between the account and the deposit-taking financial institutions played a crucial during the Financial Crisis of 2008-09 since the TGA is maintained in the Fed’s books. The upsurge in the TGA balancing arising from the Treasury’s net receipts reserves drained from the banking system. Also, in the case where there is an absence of offsetting actions, this would put pressure on the interest rate of federal funds (Adrian, 2009).
On the other hand, declines in TGA balances as a result of Treasury net expenditures boosted reserves to the entire banking system with the consequence that the is a downward pressure on the federal funds rate stemming from the absence of offsetting actions. The result of this dynamic is an important interface between the Fed operations and the Treasury. This interface required joint management during the crisis and the next section shows how the Fed and the Treasury jointly managed the interface from the onset of the financial crisis (Santoro, 2012).
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The Pre-Crisis Cash Management
The pre-crisis cash management aimed at volatility dampening of the cash reserves;
To suppress the volatility, the Fed carried out large scale open market operations (OMO) more frequently;
The key objectives were:
Tax collection;
Stabilizing the TGA balance; and
Generate interest income for the treasury
The Pre-Crisis Cash Management
The cash management prior to the crisis was aimed at volatility dampening of the cash reserves. This would have been worse if the Treasury had all the revenues as they came in into the TGA and if it had held them there up to the time of disbursement. To suppress the volatility, the Federal Reserve System would have been forced to carry out large scale open market operations (OMO) more frequently. The focus would have been to drain reserves in the instances when TGA balances were diminishing and increasing reserves when the balances were swelling (Santoro, 2012). The Treasury sought to maintain a stable balance in TGA and this worked more efficiently in its Tax and Loan program.
Before the onset of the crisis the three objectives of cash management by the treasury under the Tax and Loan program were to collect federal tax receipts, stabilize the TGA balance, and to generate (for the Treasury) interest income (Adrian, 2009).
To achieve its tax collection objective, a private deposit-taking institution could take part in Tax and Loan program by being a collector institution, a retainer institution, or an investor institution. As a collector institution, a depository institution would act as a tax collection conduit to accept tax payments from corporations and other businesses (basically personal income withholding taxes, social security contributions, and corporate taxes) (Santoro, 2012). They would then transfer the collection to the TGA. As a retainer institution the depository institutions would still accept the but this would be pegged on the limit set by the institution and also pledge collateral and retain the payments in some interest-bearing account up to such a time that the Treasury would call for them. Any excess of the Main Account above the set limit would be transferred to the TGA. As an investor institution, the depository institution accepted (from Treasury) direct investments and credited them to the Main Account upon being collateralized (Santoro, 2012).
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Cash Management by Treasury Following the Onset of the Crisis
Treasury responded by selling Treasury bills through its Supplementary Financing Program (SFP);
The was to drain (mop out) excess reserves in the banking system;
SFP comprised a series of T-bills whose proceeds were deposited at Fed’s newly created SFP A/c;
Fed’s announcement of beginning to pay interest on the reserves further led to mop-out.
Cash Management by Treasury Following the Onset of the Crisis
When the crisis began in 2008, the Treasury made the first response by selling Treasury bills through its Supplementary Financing Program (SFP). The consequence of this intervention was that the reserves were drained from the banking and cut down the excess reserve volumes. The SFP comprised a series of T-bills, save for the Treasury’s current borrowing account, whose purpose was to provide cash to be used for lending and liquidity initiatives at the Fed. The proceeds for the SFP sales were deposited at the Fed in the newly created Supplementary Financing Program account. This initiative succeeded in draining about $100 billion from the banking system (Adrian, 2009).
Fed announced that it would start paying interest on the reserve balances. This was aimed at allowing Fed to go on with the lending program so as to address the credit market conditions and to keep maintaining the funds rate as the target level, with or without the SFP. The program resulted into stability up to the end of the crisis in September 2009 when Treasury embarked on the redemption of maturing bills. This was done in expectancy of a debt ceiling constraint.
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The Treatment of the Financial Crisis
Fed and Treasury applied cash management policies to contain the crisis;
Policies aimed at cash reserve volatility dampening and price stability;
OMO enabled Fed to mop out excess reserves during crisis;
This further helped to maintain a stable TGA balance
The Treatment of the Financial Crisis
The treatment of the financial crisis by the Treasury and the Fed prior and even after can be said to be commendable. Stability of prices in the economy is a core monetary policy objective and thus was done prior to the onset of the crisis. The Fed and Treasury pursued cash management policies that targeted volatility dampening of the cash reserves (Domar, 2006). If the cash reserves are allowed to oscillate with wide amplitudes then this can subject the economy to varied levels of money supply. The effect of this would be that the prices would vary quite widely within a short period of time and thus bringing instability even into the goods prices (Mankiw, 2014).
Applying the monetary policy tools such as OMO to control the supply of currency was in order. The focus would have been to drain reserves in the instances when TGA balances were diminishing and increasing reserves when the balances were swelling. The Treasury sought to maintain a stable balance in TGA and this worked more efficiently in its Tax and Loan program (Mankiw, 2014). This was triggered by the three objectives at the time that included a continuous tax receipt flows, stabilization of TGA, and generation of interest income for the Treasury (Mankiw, 2014).
At the onset of the financial crisis in 2008, the immediate objective was to drain excess reserve volumes in the banking system. The Treasury came up with the SFP which worked effectively through its T-bills. The effect was that the cash to be used for lending and liquidity initiatives at the Fed was provided. Effectively, through the SFP about $100 billion was drained from the banking system thus bringing stability (Branson, Macroeconomic Theory and practice, 2006).
The announcement by Fed that it would start paying interest on the reserve balances with an aim of allowing Fed to go on with the lending program so as to address the credit market conditions and to keep maintaining the funds rate as the target level, with or without the SFP was very productive. It resulted into stability up to the end of the crisis in September 2009 when Treasury embarked on the redemption of maturing bills. This intervention was consistent with argument in Mankiw (2014).
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An Outline the Author’s Arguments
Two approaches key to author's argument
Cash Management: SFP was a management strategy to drain excess reserves alongside T-bill sales;
Investment Strategy: announcement of increases in interest payments caused investors to reduce their liquidity holdings thus further draining excess reserves
An Outline the Author’s Arguments
The author points, basically, at two approaches that worked best for the Fed in collaboration with the U.S. Treasury in managing the financial crisis of 2008-09. These are close working relationship between the Fed and the Treasury in cash management, and the second one is the manipulation of investment strategy through compelling T-bill purchase or sales through raising interest rates.
The SFP was a cash management tool meant to drain reserves from the banking system so as to reduce overall liquidity in the economy. This worked effectively to mop up the excess reserves. By reducing the reserves in the banking system, the banks were left with fewer funds to give to the people and this worked to contain the crisis by reducing excess flow of funds. OMO was the second cash management tool that Santoro (2012) points out. By selling T-bills to the public and the depository instituions, the Fed managed to mop out excess liquidity in the banking system and this helped it in the cash manageemnt.
The second idea fronted Santoro (2012) was that of investment stratgies. The idea was to announce increases and decreases in the T-bills rates and retirng of debts. When the Treasury announced increases in the T-bill rates, the banks and individual investors purchased more of the T-bills thus reducing the excess reserves form the banking system. A decrease in the intersest rates would trigger low demand for the same.
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References
Adrian, T. C. (2009). The Federal Reserve’s Primary Dealer Credit Facility: Federal Reserve Bank of New York. Current Issues in Economics and Finance 15, no. 4 .
Domar, H. (2006). Macroeconomic Theory and Policy. New York: sage.
Mankiw, G. N. (2014). Principles of Economics 7th Edition. South-Western College Pub.
Santoro, P. J. (2012). The Evolution of Treasury Cash Management during the Financial Crisis. current issues in Economics and Finance Volume 18, Number , 1-11.
