A closer look at the Fed’s Balance Sheet accounting (applies to other central banks as well)…

There are two subjects apart from economics which are vital to understanding monetary policy: law and accounting. We have seen importance of law in India’s demonetisation and even advent of digital currency which has made us look at terms like legal tender, currency etc that have legal meanings. Knowledge of Accounting is crucial to understanding central bank accounts which tells us how central banks add or subtract reserve money which was also a big puzzle during demonetisation. Also, law has a lot to do with how accounting will be eventually done.

 have a nice post on accounting policies followed at Fed’s balance sheet. This applies to most central banks as well:

When a Reserve Bank purchases a Treasury security, it purchases an asset, typically from a bank or broker-dealer. It credits reserves (a liability of the Fed) to the reserve account of the seller (or the seller’s bank). The bank or broker-dealer may sell its own securities or may act as an agent on behalf of a client. As a holder of a Treasury security, a Reserve Bank has no special rights relative to other Treasury-holding entities. The Treasury security that the Fed has purchased is not “paid in full.” It remains an asset on the Fed’s balance sheet until the security matures or is redeemed by the Treasury in accordance with the terms of issuance. 

As the nation’s central bank, the Fed plays a number of important public policy roles, and monetary policy does indeed have fiscal implications. In trying to understand the effects of the Fed’s actions on public finances and debt, it can be convenient, in some cases, to think about a consolidated public sector balance sheet that sums together the respective assets and liabilities held by the Fed and the federal government. Nevertheless, as noted in an answer to a comment on our earlier post, the Federal Reserve Banks are independent entities, with their own balance sheets, separate from that of the Treasury. There is no authority to consolidate Reserve Bank and Treasury balance sheets. 

One might wonder whether the Fed could coordinate with the Treasury and agree to an accounting offset, so that every time the Fed buys a Treasury security, the security is considered “paid in full.” In fact, neither the Board of Governors nor any Reserve Bank is authorized under the Federal Reserve Act to fund the repayment or retirement of a Treasury security; only the Treasury can do so, and it can do so only under the terms under which it issued the security. 

Even if it could coordinate with the Treasury and agree to an accounting offset every time it buys a Treasury security, the Fed may prefer to hold on to these assets for future use. Indeed, just like any other entity with Treasury holdings, a Reserve Bank may resell or lend Treasury securities—as the New York Fed does—subject to the Section 14 open market limitation and FOMC directions. But again, a Reserve Bank does not have the authority to fund the payment or retirement of Treasury securities, which are obligations of the U.S. government. 


One Response to “A closer look at the Fed’s Balance Sheet accounting (applies to other central banks as well)…”

  1. A closer look at the Fed’s Balance Sheet accounting (applies to other central banks as well)… - Daily Economic Buzz Says:

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