Throughout history, central banks have had a close working relationship
with the Treasury of their country. While this cooperation changed with
economic and political circumstances, the Treasury and central bank usually
have worked together to promote economic and financial stability. The role
of the central bank as a depository and fiscal agent of the Treasury is a
central part of this close cooperation.
Today, as depository and fiscal agent of the federal government, a central
bank pro- vides and manages a bank account for the Treasury. It monitors
expenses and receipts to ensure that overdrafts do not occur (technically a
central bank could provide an over- draft but the law usually forbids it).
It collects and settles payments made to the Treasury (taxes, licenses,
fines, and so on) and it clears checks drawn on the Treasury's account. The
central bank is also responsible for the overseeing of the Treasury's
transactions related to the public debt and to interventions in
foreign-exchange markets. It oversees the bidding process, delivers
treasuries to the bid winners, and credits the proceeds to the Treasury's
account. It also redeems maturing treasuries, pays coupons, and oversees
refinancing operations (Federal Reserve Bank of St Louis, 2004).
While the provision of basic financial agency services by the central bank
is uncon- troversial, the extension of this duty to the direct financing of
the Treasury has not been. Even open-market operations that involve
outright purchases of treasuries in the secondary market have sometimes
been controversial.
Most early central banks were created to provide direct financial support
to the Crown, but the growth of democracy was accompanied with a growing
reluctance to allow such direct financing (Capie et al., 1994). However,
during trying times such as wars or deep financial crises, direct financial
help to the Treasury has been provided. For example, the 1914 Federal
Reserve Act did not forbid such direct financing until a 1935 amendment to
Section 14. However, at the request of the Federal Reserve, the 1942 Second
War Powers Act removed the 1935 prohibition, subject to reapproval by
Congress every two years; and Congress did so until 1979. During World War
II, the Federal Reserve also continu- ously purchased treasuries in the
secondary market to set the entire treasuries yield curve. Political
tensions between the Treasury and the Federal Reserve emerged at the end of
the war and ultimately led to the 1951 Accord that freed the Federal
Reserve from the need to keep treasuries rates low. Quantitative easing is
another example of similar yield curve targeting, albeit not as strong as
during World War II (Tymoigne, 2014).
In normal times, the central bank may also participate in treasuries
auctions in order to maintain the stability of the treasuries market. For
example, currently the Federal Reserve is not a net buyer of treasuries in
the primary market but it does buy treasuries directly from the Treasury to
replace those that are maturing in its portfolio, which pro- vides a stable
refinancing source for the Treasury. Until the 1970s, unsuccessful
offerings of bonds and notes were common and the Federal Reserve had to be
the net buyer of last resort (Garbade, 2004). Today, the central bank makes
sure that primary dealers have the funds they need in order to make a
treasuries auction successful.
While uncontroversial in the United States, the European Central Bank (ECB)
has avoided outright purchases in the secondary market in normal times. It
could have done so from its inception, but German ECB members saw this as
an implicit bypass- ing of the prohibition of direct financing of public
spending. The 2010 euro-area crisis forced the ECB to change its position,
first unconditionally in a limited way through the Securities Markets
Programme (SMP) in 2010, and then conditionally in an unlimited way through
the Outright Monetary Transactions programme in 2012 (Coeuré, 2013).
The adoption of the SMP triggered the resignation in 2011 of Jürgen
Stark, the German member of the ECB Executive Board, and Axel Weber,
President of the German Bundesbank.
In conclusion, throughout history the relationship between the central bank
and the Treasury has always been one of mutual support. Both have aimed at
maintaining the sta- bility of the financial system in which the federal
government plays a central role. While the politics surrounding this close
cooperation between the Treasury and the central bank has sometimes been
heated, the economics has been straightforward and is well under- stood by
insiders (see Snyder, in US Senate, 1952; MacLaury, 1977; Meulendyke, 1998;
and Newman, 2013).
See also:
Chartalism; European Central Bank; Federal Reserve System; Modern Money
Theory; Open-market operations; Outright Monetary Transactions;
Quantitative easing; State money; Yield curve.
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