Wednesday, February 24, 2010

Hamilton on the Treasury Supplementary Financing Program (SFP)

Warning: geekiness level more elevated than usual.

Hamilton thinks the increase in the SFP is rather surprising given the other "outs" the Fed could use, and it may be part of a broader, still undisclosed strategy. This strategy in my opinion would simply be the unlegislated bailout of Fannie and Freddie.

1 comment:

  1. Wow, this requires some thought. My initial reaction is below:

    Back in 2008, the Treasury borrowed money in the open market and gave the proceeds (SFP) to the Fed to use in its emergency liquidity programs. If it had not, the Fed would have had to "print money" instead.

    In 2009, the government was facing a debt ceiling, which meant that the Treasury had to reduce its account at the Fed so that the government could avoid the debt ceiling. Now that the debt ceiling has been raised by Congress, the Treasury has increased its account at the Fed again.

    The Fed is preparing to replace excess reserves at banks with Treasury bills and thereby drain those excess reserves (high powered money) back into the Treasury account to pay back the Treasury. If it did not do it this way, the Fed would have to replace reserves with securities from its own balance sheet, which is inflationary. Excess reserves are not inflationary unless banks take the money out of reserves and lend it.

    In essence, the Fed needs a third party - the Treasury - to provide the funds or to receive the funds in order to avoid such transactions from becoming inflationary or deflationary. The Treasury's borrowing/spending does not increase/decrease the money supply whereas the Fed's buying/selling of securities does.

    Lastly, if the Fed's did not drain money out of excess reserves prior to raising rates, then banks get a free ride.