 |  Money and Capital Markets: Financial Institutions and Instruments in a Global Marketplace, 8/e Peter Rose,
Texas A & M University
The Treasury in the Financial Markets
Chapter SummaryIn this chapter, we examined the many roles played by the Treasury Department in financing
federal expenditures and managing the public debt of the United States.
- The federal government affects the financial system and the economy through its taxing
and spending activities which are known as fiscal policy.
- The government can also set in motion changes in the financial system (particularly in
interest rates and the volume of credit) and changes in the economy through debt management
policy which involves changing the mix or composition of the government’s
debt (e.g., changes in the ratio of short-term to long-term securities outstanding).
- When the government increases its borrowing and spending activity interest rates tend
to rise. Income and spending also tend to move higher unless the central bank offsets the
government’s fiscal policy action. The money supply will tend to rise, resulting in interest
rates falling at least for a time. Should inflation subsequently pick up, however, interest
rates may rise again as nominal interest rates move higher to reflect additional
expected inflationary pressures.
- Should the government run a budget surplus and, therefore, need to borrow less money,
interest rates would tend to decline as will income and spending in the economy. If the
budget surplus is relatively large, a substantial portion of that surplus may be used to retire
outstanding government debt. Not only will income and market interest rates tend to
fall, but so will the nation’s money supply unless the central bank acts to offset the impact
of the government’s debt retirement program. Inflation may be lessened, but unemployment
may rise.
- The government can also use debt management policy to change conditions in the financial
markets and the economy. For example, suppose the Treasury refunds maturing
short-term securities with new long-term securities. This action will tend to reduce the
liquidity of the public’s security holdings. Interest rates would tend to rise, while income
(spending and production) and employment would tend to fall. Long-term government
borrowing, therefore, tends to slow the economy’s growth rate and reduce inflationary
pressures.
- In contrast, a government policy that emphasizes short-term borrowing often leads to
rapid economic expansion and less unemployment. However, these benefits of a short-term
debt policy are sometimes purchased at the price of greater inflation and, therefore,
higher interest rates eventually.
- Fiscal policy and debt management policy, like central bank monetary policy, focus
upon promoting full employment and economic growth and in keeping inflation under
control. But these different forms of public policy must be coordinated for maximum effectiveness;
otherwise, they may offset each other with little positive impact.
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2003 McGraw-Hill Higher Education