The Fed’s Income Must Also Mean The Nation’s Well-Being

By Chandrashekar (Chandra) Tamirisa, (On Twitter) @c_tamirisa

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The nation’s central bank lends money to earn interest income. The money it lends is the money which only it can print, by government edict or fiat. And only it can decide when to print and how much. Most of its income, under normal circumstances, comes from the yields on the treasury securities on its balance sheet. The yields are fixed payouts over the time of maturity of a treasury security. This is also known as the term structure of interest rates or the yield curve which is supposed to portend the future of the U.S economy.

Fed’s income, therefore, unless the government is running a surplus, is strictly not a profit. It is the monies paid to the Fed by the rest of the government (or the U.S tax payer) for serving as the nation’s central bank. If the government is running deficits, given that money is fungible, the central bank is being paid by budget deficits to do its work. Meaning, the Fed, like a long lost distant cousin paying your salary, can be argued to being paid by the Chinese and the Saudis, let alone by its near kith and kin of the hordes of bond traders on Wall Street who also make a decent living buying and selling more treasury securities than the specter of foreigners.

The reason for the Fed to supply money the way it does as the largest player in the government bond market in New York is known by the name of Keynesian Economics: effectively, the government budget finances the central bank out of its tax receipts. Which is also in part why the Secretary of the Treasury both signs the Federal Reserve Notes (or the dollar bills) and the treasury securities. Tim Geithner cuts Ben Bernanke’s paycheck. So much for central bank independence.

The Fed, therefore, is not really independent. This is neither good nor bad but for all that hyper-excitement in the economics profession about the sanitization of the central bank from the supposed pollution by politics. The Fed’s landscape is politics and this is the way it must be in a democratic society. This is the reality, whether the Fed buys and sells treasury securities or privately created securities to adjust the nation’s money supply. I call making monetary policy by buying and selling private securities and the associated term structure of interest rates non-Keynesian monetary policy, an innovation for which I could be disbarred from the American Economic Association (AEA) for disrespecting the old man, let alone getting that paper published or dreaming of a Nobel for its very sensible radicalism. Such is the depth of Keynesian dysfunction permeating the economics profession. It is an intellectually stifling monopoly. Yet, extraordinary times call for extraordinary radicalism without which Keynes would have been a name no one would have recognized today (or the United States centuries before Keynes for that matter).

The Fed makes one component of the nation’s macroeconomic policy and some of its microeconomic policy: under current law, it sets interest rates by modulating money supply and subjects its member banks to its regulatory authority. It does so in the context of other macroeconomic policies such as fiscal policy (government budgets and taxes) and trade policy and other government regulations that affect the economy.

Still, just as any other government bureaucracy, the Fed is also a government bureaucracy but with the capacity to earn revenue for doing its job instead of seeking Congressional appropriations, even though only as a matter of budget accounting, because the Monthly Treasury Statement (MTS) shows the Fed as a net contributor to the government receipts only if it is assumed that the government has written off the equivalent of the Treasury bonds it has given the Fed to let it begin to operate. The government receipts from the Fed are in reality net of what the government pays the Fed for its operations.

What if the Fed wanted more income for its operations? This is a decision which it independently makes based on the economic need for more money, not because it changes how it operates without in some manner consulting with the Congress (to whom it reports semi-annually), White House (which appoints its Board) or the Treasury (which manages the government’s budget), but because it has sole authority over the rationale for changing how much money it supplies and when. This is the meat of the Fed’s work that few outsiders have any insight into, let alone most of the Fed’s economist staff.

A down economy requires more money and a normal economy requires less (also known as the business cycle) and it is appropriate then to ask if the Fed is responsible, in some measure if not all, for business cycle fluctuations to maximize its income. Bankers on Wall Street and the nation’s central bank, coincidentally, raise their revenues at the same time when money supply expands and, therefore, it seems logical that, whatever its appropriateness, higher banker incomes are also in the interest of the Fed or, simply put, the Fed appears to be in existence to support the bankers’ interests. And as a necessary corollary, looking forward, if the Fed can operate differently to ameliorate business cycle fluctuations which it seems to be causing to some degree now, whether that be its intent or not?

A starved bureaucracy is not a happy bureaucracy and bureaucrats, by nature, don’t like to be starved but fattened whether that be by Congressional appropriations or some form of quasi-self-financing as is the case with the Fed (and the International Monetary Fund). It is relevant, therefore, to examine the link between Fed policy and its operations vis-à-vis the Fed’s operational budget and its distribution. A government agency so concerned about the rising government deficits, while being dependent on it for its well-being, should also be concerned about how much it returns to the Treasury by minimizing its operational expenditures to the extent feasible. In this, the Fed and the Treasury bear the most responsibility, more than other government bureaucracies.

The Federal Reserve is mutually dependent on the rest of the government to ensure the nation’s economic health. The issue, therefore, is not Fed independence but the capacity of the government as a whole to be economically sensible. In the economics profession, this is known as time consistent behavior: the maintenance of sound money and responsible budgets over all time horizons―short, medium and long, not the cycles of euphoria and fear. But that is, unfortunately, still the realm of economic and political theory in the United States.


About Chandrashekar (Chandra) Tamirisa
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