TREASURY BONDS & MONETARY POLICY
United States Treasury securities are used throughout the world as the foremost interest-bearing asset issued by any nation. These marketable bonds are the backbone of global finance, as millions of individuals and corporations rely on the “full faith and credit” of the U.S. Government to repay its debts. There is no global equal in terms of breadth, depth, or liquidity considerations.
Apart from individual investors, financial institutions, private corporations, pension/retirement funds, and foreign governments buy Treasuries for their safety and liquidity features. As of December 2016, total foreign holdings came right at $6 trillion of Treasury bonds, with Japan surpassing China as the single largest foreign owner.
The Federal Reserve System also utilizes Treasury securities as part of its operation. Unlike other end-users of a bond (read: investors), the Fed is not buying Treasury bonds to make money. Rather the Fed is using these bonds as an instrument in governing America’s monetary policy.
Monetary policy is the process by which the monetary authority of a country, such as a central bank or currency board, controls the supply of money, often targeting an inflation rate or interest rate to ensure price stability and general trust in the currency.
The Federal Reserve has a dual mandate according to law: maximize employment in the U.S. job market while maintaining stable prices and a moderate, long-term interest rate. To put this another way, keep Americans working while controlling inflation.
One of the tools available to Federal Reserve System’s is the use of something known as Open Market Operations. As the Federal Reserve’s own website explains:
“This tool consists of Federal Reserve purchases and sales of financial instruments, usually securities issued by the U.S. Treasury, Federal agencies and government-sponsored enterprises. Open market operations are carried out by the Domestic Trading Desk of the Federal Reserve Bank of New York under direction from the FOMC. The transactions are undertaken with primary dealers. When the Fed wants to increase reserves, it buys securities and pays for them by making a deposit to the account maintained at the Fed by the primary dealer’s bank. When the Fed wants to reduce reserves, it sells securities and collects from those accounts.”
By purchasing Treasury securities, the Federal Reserve INCREASES the nation's money supply, giving banks more money to lend. This measure is designed to stimulate the economy. The introduction of new money is known as Quantitative Easing.
By selling Treasury securities, the Federal Reserve DECREASES the nation's money supply. This measure is designed to slow down the economy. This policy would be implemented if the Fed wants to contract the money supply.