There’s No Struggle Between Fed and Treasury Right Now
If you listen to the high priests of financial analysis—a group that includes hedge fund managers, Wall Street economists, and even pixel-stained pundits in the financial press—there’s a battle going on for the soul of the bond market.
On one side is Treasury Secretary Scott Bessent, buying back long-term government bonds. On the other is Federal Reserve Chairman Kevin Warsh, who must decide whether to help bring yields down or leave Bessent “in even deeper trouble,” as a newsletter from the Wall Street Journal recently put it.
There is just one problem with this account: Warsh and Bessent are not battling each other. And they do not see themselves as being on opposite sides.
Bessent regards the repurchase of Treasury debt as debt management, which is the responsibility of the Treasury Department. Warsh regards interest rate policy and control of the Fed’s balance sheet as monetary policy, which belongs to the central bank. He can support Treasury buybacks while maintaining a hawkish stance against inflation. He is perfectly comfortable with Bessent undertaking fiscal operations while he concentrates on monetary policy.
How QE Ate Fiscal Debt Management
The strange thing is that the confusion surrounding Bessent’s buybacks vindicates one of the oldest criticisms of quantitative easing.
When the Fed began buying mortgage-backed securities and long-term Treasury debt in the aftermath of the financial crisis, critics warned that it was crossing the boundary into fiscal policy. Philadelphia Fed President Charles Plosser argued that credit-allocation decisions belonged to fiscal authorities. Richmond Fed President Jeffrey Lacker described credit policy as “a form of fiscal policy.” Monetary historian Michael Bordo said the Fed had become involved “in debt management through quantitative easing.”
The objection became even stronger when the Fed launched Operation Twist, selling shorter-term securities and buying longer-term bonds. Treasury could accomplish the same maturity transformation by changing the mix of bills, notes, and bonds it issued. The Fed was using its balance sheet to do something that looked an awful lot like Treasury debt management.
After nearly two decades, the Fed apparently has acquired the territory by adverse possession—at least, in the minds of many financial journalists and economists.
Because the central bank spent so long purchasing government bonds, many pundits have come to regard any government bond purchase as inherently monetary. When Treasury buys back its own securities, Bloomberg calls it a form of “quantitative easing,” and the Journal calls it an unusual intervention in the bond market. Treasury is now accused of trespassing on ground that belonged to Treasury before the Fed wandered onto it.
The mechanics have helped create the confusion. If Treasury spends money from its account at the Fed to repurchase a bond, the transaction adds reserves to the banking system and removes a longer-term security from private hands. Viewed only through the consolidated government balance sheet, that can resemble QE.
Debt Management Is Not QE
But Treasury spending, tax collections, debt issuance, and cash management always alter bank reserves and bond balances. That does not make every tax payment or Treasury auction an act of monetary policy. The Fed can offset reserve movements whenever they conflict with its desired policy stance. What’s more, when the Treasury buys a security, it pays for it from revenue collected from taxes or bond sales. When the Fed does so, it simply uses keyboard entries to create new bank reserves.
Treasury debt management also inevitably affects yields. Issuing more short-term bills, reopening an old bond, changing auction sizes, or repurchasing an illiquid security will change prices somewhere in the market. Every time the Treasury decides how much debt to issue at a particular auction and what maturities it will sell, it is “manipulating” the term structure of government debt and putting a finger or even a fist on the yield curve. If affecting yields turns debt management into monetary policy, the Treasury has no meaningful authority to manage the debt.
But we spent so long in the world of quantitative easing—what the Fed once quaintly called “extraordinary” measures—that Treasury managing its own liabilities is seen as improper interference. The Fed helping to contain the government’s borrowing costs is treated as normal central banking.
That is the institutional world the critics of QE warned about. It’s something that concerned Warsh himself when he was a Fed governor two decades or so ago. The Fed performed fiscal-style functions for so long that the financial commentariat forgot where those functions originally belonged. The confusion over Bessent’s buybacks may be one of QE’s most enduring legacies.
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