But on the other hand, the Treasury does not necessarily want to shorten duration. There is still a residual concern in policy circles of rates backing up. Yes, this limits the gains from the Fed action. 100%. It makes QE all the more ineffective. If the Treasury and the Fed were acting in concert, the Treasury would be limiting its schedules of 5 or 10-year auctions and instead shortening duration as it had done under Rubin. I am not aware that it is doing so.

It doesn’t seem that the Fed and the Treasury are acting in concert.

Whenever the treasury runs a deficit it creates an asset. Those bonds become an asset of the banks. The Fed can create assets as well; zero interest zero duration government liabilities called money.

If the Fed trades money for longer duration bonds it is merely shortening the asset duration of the private sector. Thus, its removing interest rate risk from the private sector. When you talk about “locking in low rates” this action acts in total opposite to this goal. You are locking in short rates rather then long rates. You are limiting the potential gains to be had from monetizing the debt because the private sector is short, rather then long, duration.

As far as the Fed’s opportunity cost in holding to duration, if you look at the Fed as a profit-maximizing organization, it is true that they could be foregoing yield. But I don’t see that as their function.

Basically the Fed can create as many dollar credits as it wishes and buy as many bonds as it wishes, holding them to maturity without having to incur a capital loss. That is a central facet of fiat money, by the way – and a principal reason those talking about US sovereign default are off base.

Also, if we view the Fed and the treasury as one entity why can’t the treasury simply issue more low duration bonds rather then high duration ones. Isn’t the Fed’s QE doing the same thing by shortening duration of outstanding government liabilities.

It’s not “monetising” the debt. As long as the Fed has a mandate to
maintain a target fed funds rate, the size of its purchases and sales of
government debt are not discretionary. Once the Federal Reserve Board of
Governors sets a fed funds rate, the Fed’s portfolio of government securities
changes only because of the transactions that are required to support the funds
rate. The Fed’s lack of control over the quantity of reserves underscores
the impossibility of debt monetization. The Fed is unable to monetize the
federal debt by purchasing government securities at will because to do so
would cause the funds rate to fall to zero. If the Fed purchased securities
directly from the Treasury and the Treasury then spent the money, it’s
expenditures would be excess reserves in the banking system. The Fed would be
forced to sell an equal amount of securities to support the fed funds target
rate. The Fed would act only as an intermediary. The Fed would be buying
securities from the Treasury and selling them to the public. No monetization
would occur. To monetize means to convert to money. Gold used to be monetized
when the government issued new gold certificates to purchase gold. In a
broad sense, federal debt is money, and deficit spending is the process of
monetizing whatever the government purchases. Monetizing does occur when the
Fed buys foreign currency. Purchasing foreign currency converts, or
monetizes, that currency to dollars. The Fed then offers U.S. Government
securities for sale to offer the new dollars just added to the banking system a
place to earn interest. This often misunderstood process is referred to as
sterilization.

When we talk about central banking operations being about “price not
quantity” it simply means that the Fed

can simply target their desired term structure of rates by offering to buy
unlimited amounts of Treasury securities at their desired rate targets,
and not worry about the mix between reserves and Treasury securities that
resulted.

In a message dated 11/20/2010 3:02:34 A.M. Mountain Standard Time,
writes:

Jim (unregistered) wrote, in response to Edward Harrison:

Right, I get that. The banks can’t lend out their reserves. But can they
buy more Treasuries with them? Because if they can, is this not monetising
the State debt? Its just a conveyor belt from the Fed (printed money) to
the State (who spends the money in the real economy) with the banks being the
middle man that allows the big wigs to claim they aren’t monetising the
debt? The crucial point is – if there was no QE would there be enough buyers
for Treasuries?

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