Policies pursued by the U.S. Treasury during the 2007-2009 financial crisis undercut the Federal Reserve's efforts to stimulate the economy, a troubling example of two economic powerhouses working at cross purposes at a critical time, a team of top economists has concluded.
In a paper released on Tuesday, a Harvard University research team including former U.S. Treasury Secretary Lawrence Summers argued that the two agencies should break down the traditional barrier set between them to better coordinate the Treasury's management of public debt with the Fed's management of monetary policy.
As it stood, even as the Fed bought bonds to lower long-term interest rates, the Treasury was ramping up its issuance of longer-term debt to stabilize the government's borrowing costs, putting upward pressure on those same long-term rates.
The paper estimated that Treasury's shift to lengthen debt maturities blunted the impact of the U.S. central bank's quantitative easing programs by as much as a third.
The conflict in policy was particularly noteworthy because the Fed had already cut interest rates to near zero and had few tools other than quantitative easing to affect monetary conditions.
Fed board member Jerome H. Powell said in response that he thought the idea of Fed cooperation with Treasury was "fraught with risk" and would jeopardize the central bank's independence.
The Fed jealously guards its independence, and the two agencies usually avoid even commenting in public about the other's operations. Summers and the other Harvard economists said that red line should be eased so Treasury and Fed officials could collaborate, perhaps in a yearly strategy statement that would minimize conflicts without committing the Fed to a particular monetary policy path.
"From a normative perspective it seems very odd that the Federal Reserve is taking actions that have the effect of substantially reducing the duration of the debt held by the public at a time when the Treasury is arguing that it is in taxpayers' interest to extend the duration of the debt at a rapid pace," the group wrote.
"The Treasury is taking steps that in the judgment of the Fed are contractionary."
In the paper, which was presented at the Brooking Institution, the authors reassessed some standing assumptions about how the government finances its debt.
For example, the Treasury has been trying to lengthen the overall maturity of its outstanding debt to lock in low borrowing costs. Though short-term debt pays a lower interest rate, it also expires more quickly and forces the debtor to refinance at a higher cost when rates rise.
However, the group examined the issue and concluded that Treasury may well be better off relying on short-term debt to take advantage of the lower interest rates paid on shorter-term notes even at the risk of paying more as rates rise.
Had the government done nothing but sell three-month Treasury bills since 1952, they concluded, it could have saved a third of a point of GDP annually and had a lower overall debt level.
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