The Treasury In The Financial Markets

1. 19 The Treasury InThe Financial Markets C h a p t e r Money and Capital Markets Financial Institutions and Instruments in a Global Marketplace Eighth Edition Peter S. Rose McGraw Hill / Irwin Slides by Yee-Tien (Ted) Fu

2.  Learning Objectives  • To examine the many important roles played by the government’s Treasury Department. • To identify how the government raises new funds and how it spends the funds raised. • To understand how the activities of the Treasury Department impact the money and capital markets and the economy. • To explore two key government policy tools – fiscal policy and debt management.

3. Introduction • The U.S. Treasury Department exerts a potent impact on the financial system through its • fiscal policy – the taxing and spending programs of the federal government designed to promote various economic goals, and • debt management policy – the refunding or refinancing of the federal government’s debt in a way that contributes to its economic goals and minimizes the debt burden.

4. The Fiscal Policy Activities ofThe U.S. Treasury • Congress dictates the amount of funds the federal government will spend each year on programs like welfare and national defense, and also determines the sources of tax revenue and tax rates. • When tax revenues are not sufficient to cover expenditures, a budget deficit occurs. • A budget surplus occurs when government revenues exceed expenditures.

5. Federal Government Revenues, Expenditures, and Net Budget Surplus/Deficit $ Billions Outlays Receipts Surplus or Deficit (-) Fiscal Years Data Source: U.S. Office of Management and Budget The Fiscal Policy Activities ofThe U.S. Treasury

6. Federal Government Revenues, Expenditures, & Net Budget Surplus/Deficit Source: U.S. Office of Management and Budget The Fiscal Policy Activities ofThe U.S. Treasury

7. The Fiscal Policy Activities ofThe U.S. Treasury Recent Tax and Expenditure Legislation • The Economic Recovery Tax Act (1981) aimed to simulate savings and business investment in order to reduce inflationary pressures in the economy. • The Gramm-Rudman-Hollings Balanced Budget and Emergency Deficit Control Act (1985) mandated reduced budget deficits. • The Economic Growth and Tax Relief Reconciliation Act (2001) was designed to encourage the public to save more.

8. The Fiscal Policy Activities ofThe U.S. Treasury Effects of Government Borrowing • Borrowing from the nonbank public • higher incomes, spending, and interest rates • Borrowing from depository institutions • no change in the money supply or total reserves; total income, spending, and interest rates rise • Borrowing from the Federal Reserve banks • money supply increases; total reserves are unchanged, but excess reserves fall; total income, spending and interest rates rise

9. The Fiscal Policy Activities ofThe U.S. Treasury Effects of the Retirement of Government Debt • Retiring debt held by the nonbank public • lower incomes, spending, and interest rates • Retiring debt held by depository institutions • no change in the money supply or total reserves; total income, spending, and interest rates fall • Retiring debt held by Federal Reserve banks • money supply decreases; total reserves are unchanged, but excess reserves increase; total income, spending and interest rates fall

10. The Fiscal Policy Activities ofThe U.S. Treasury • The conventional view of government borrowing adding to income and possibly driving up interest rates and inflation has been challenged in recent years. • It was pointed out that interest rates and prices may not rise if an equal amount of private borrowing and spending are crowded out, or if the added government borrowing has already been anticipated and discounted by the market.

11. Management of the Federal Debt • Corporations, commercial banks, and other institutional investors rely heavily on government securities as a readily marketable reserve to be drawn upon when cash is needed quickly. • Today, the U.S. public debt is the largest single collection of securities available in the financial system.

12. The U.S. Public Debt $ billions Data Source: Bureau of the Public Debt The Size and Growth of the U.S. Public Debt

13. The Size and Growth of the U.S. Public Debt • On a per capita basis, the U.S. public debt amounts to more than $20,000 for every man, woman and child living in the U.S. • How did the federal debt become so large? Wars, economic depressions, and the rapid expansion of military expenditures and social programs have been among the principal causes.

14. 19 - 14 The Composition of the Public Debt Source: Bureau of the Public Debt

15. 19 - 15 (In billions of dollars) Investor GroupDec 2000 Jun 2001 Federal Reserve & Government accounts … 2,781.8 3,004.2 Privately held: Depository institutions ……………………… 198.9 190.1 U.S. savings bonds …………………………… 184.8 185.5 Pension funds Private ……………………………………… 137.7 127.5 State and local governments ……………… 195.7 197.1 Insurance companies ………………………… 110.2 94.8 Mutual funds ………………………………… 312.5 333.2 State and local governments ………………… 236.2 216.5 Foreign and international …………………… 1,201.3 1,167.4 Other investors ……………………………… 303.1 210.5 Total privately held …………………………… 2,880.4 2,722.6 Total public debt ………………………… 5,662.2 5,726.8 Data Source: Treasury Bulletin, Department of the Treasury (U.S.) Investors in U.S. Government Securities

16. Methods of Offering Treasury Securities • Treasury debt managers are called on continually to make decisions about raising new money and refunding maturing securities. • They must decide what kinds of securities to issue, which maturities will appeal to investors, and the form in which an offering of securities should be made.

17. Methods of Offering Treasury Securities • The auction method is the principal means of selling Treasury notes, bonds, and bills today. • Examples of auction methods used include the yield auction, uniform price auction, and “reverse auction.” • Today, the marketable public debt is issued in book-entry form only .

18. Methods of Offering Treasury Securities • New Treasury bills, notes, and bonds can be bought directly from the Treasury Department or from the Treasury’s agents – the Federal Reserve banks. • Many investors also place orders for new Treasury issues through a security broker or dealer, bank, or nonbank financial institution.

19. The Goals of Federal Debt Management • Housekeeping goals pertain to the cost and composition of the public debt, such as minimizing interest costs and reducing the frequency of refundings. • Stabilization goals relate to the impact of the debt on the economy and the financial markets. • The goal of economic stabilization often conflicts with other debt management goals.

20. The Impact of Federal Debt Management • Most experts agree that in the short run, the financial markets become more agitated and interest rates tend to rise when the Treasury is borrowing. • There is also some evidence that lengthening debt maturities increases long-term interest rates relative to short rates.

21. The Impact of Federal Debt Management • However, most authorities are convinced that the debt management activities of the Treasury do not have a major impact on economic conditions. • The effects of debt management operations appear to be secondary compared to the impact of monetary and fiscal policy on the economy and the financial markets.

22. Money and Capital Markets in Cyberspace • Find out more about the Treasury by visiting: • http://www.treas.gov/ • http://www.publicdebt.treas.gov • http://www.treasurydirect.gov/ • http://www.imf.org/external/np/mae/pdebt/2000/eng/ • http://www.iga.ucdavis.edu/

23. Chapter Review • Introduction • The Fiscal Policy Activities of the U.S. Treasury • Sources of Federal Government Funds • Federal Government Expenditures • Recent Tax and Expenditure Legislation • Effects of Government Borrowing on the Financial System and the Economy • Effects of the Retirement of Government Debt

24. Chapter Review • Management of the Federal Debt • The Size and Growth of the Public Debt • The Composition of the Public Debt • Marketable Public Debt • Nonmarketable Public Debt • Investors in U.S. Government Securities • Methods of Offering Treasury Securities • The Goals of Federal Debt Management • The Impact of Federal Debt Management on the Financial Markets and the Economy