“The Fed Buys U.S. Securities”

A truth subject to misinterpretation.

Introduction

“The Federal Reserve purchases U.S. Treasury Securities to expand the money supply.” This statement contains some misinformation, and some truth and can be misleading.

I will deal with these three points in order:

Misinformation

I have explained in an earlier post [“Who Actually Makes Money”] that the Federal Reserve only creates Reserve Dollars. It does not create money.

Truth

The Federal Reserve does indeed purchase U.S. Treasury Securities.

The Federal Reserve purchases Treasury securities held by the public through a competitive bidding process.

(All quotes in this article were taken from the source listed at the bottom.)

However, this true statement may become a little misleading when stated simply.

Misleading

The statement is misleading because some people might believe that the Federal Reserve purchases U.S. Treasury Securities directly from the U.S. Treasury. The Federal Reserve does not, however, purchase U.S. Treasury Securities directly from the U.S. Treasury.

The Federal Reserve does not purchase new Treasury securities directly from the U.S. Treasury…

Financing The Federal Deficit

Federal Reserve purchases of Treasury securities from the public are not a means of financing the federal deficit.

When the Federal Government “spends” more dollars than it receives from taxes, it makes up the difference (the deficit) by borrowing dollars by selling U.S. Treasury Securities. It sells those securities to two categories of buyers (but not The Fed): Banks and Non-Banks.

Sales to:

Banks

Banks create new money dollars to pay for the securities they buy at Treasury Auctions. These new money dollars expand the money supply and add to inflation.

Non-Banks

Non-banks do not create new money dollars to pay for the securities they buy at Treasury Auctions. They transfer account balances to the recipients of government payments. That activity creates no new money dollars.

The Federal Reserve Buys Securities

The Federal Reserve purchases Treasury securities held by the public through a competitive bidding process.

The Federal Reserve only buys Treasury securities in the open market that have been previously purchased by one of two types of sellers: Banks and Non-Banks.

Purchases from:

Banks

When the Federal Reserve purchases U.S. Treasury Securities from banks, The Fed pays for them by increasing the amount of the bank’s reserves in reserve dollars. Because of the zero reserve requirement, banks probably have no unfulfilled loan demand and thus no incentive to increase the number of money dollars. Thus, increasing the reserve balance has no inflationary effect.

Non-Banks

When the Federal Reserve purchases U.S. Treasury Securities from nonbanks, it does cause the number of money dollars to increase. To pay for the securities, The Fed adds reserve dollars to the reserve account of the bank where the non-bank seller has its bank account. The bank must then create money dollars by increasing the deposit liability for the seller’s account.

Conclusion

Yes, the Federal Reserve does purchase U.S. Treasury Securities. From whom the Fed purchases securities makes a big difference.

1. The Fed does not purchase U.S. Treasury Securities directly from the treasury.
2. The Fed does purchase U.S. Treasury Securities from two types of sellers in secondary markets.
   1. When the Fed purchases securities from banks, it does nothing to increase the number of money dollars, thereby having no effect on inflation.
   2. When the Fed purchases securities from nonbanks, it does cause a limited increase in the number of money dollars. To accommodate the purchases by their non-bank customers, banks must increase the number of money dollars.

When you hear that the Federal Reserve has purchased U.S. Treasury Securities, make no assumptions until you know from whom the Fed has made those purchases.

Source

The Federal Reserve Board of Governors