Factors That Subtract from the Monetary Base

Treasure Deposits at the Fed The funds the Treasury gets from tax payments and proceeds from the sale of government bonds are initially held in accounts at the commercial banks called tax and loan accounts and are then deposited in accounts at the Fed used by the Treasury to write al its checks. Suppose the Treasury intends to pay for a $100 million B2 stealth bomber, and it transfers $100 million from its tax and loan accounts to its account at the Fed, resulting in the following T-account:

The commercial banks now find that they have lost $100 million in deposits and hence $100 million in reserves, so their T-account is

At the Fed, reserves decrease by $100 million while Treasury deposits have increased by $100 million:

Consequently, an increase in U.S. Treasury deposits reduced reserves and the monetary base (as shown in the Table 18.2).

When the Treasury pays for the stealth bomber, the preceding process is reversed. U.S. Treasury deposits at the Fed fall by $100 million, and the defense contractor deposits the check received from the Treasury in its bank, whose reserves rise by $100 million. The T-account for the Federal Reserve is

We again see that the monetary base moves in an opposite direction to Treasury deposits with the Federal Reserve.

Because Treasury purchases and receipts change dramatically during the course of a year, Treasury deposits with the Fed have large fluctuations and consequently can be an important source of weekly fluctuations in the monetary base. Fluctuations are fairly predictable though, because the Treasury usually knows in advance when it plans to move funds from its tax and loan accounts into its accounts at the Fed. In additional, because most of the fluctuations in Treasury deposits are temporary, they are not a major source of fluctuations in the monetary base over longer periods of time (such as three months or a year).

Foreign and Other Deposits at the Fed When these deposits rise, either because funds from accounts at commercial banks are transferred into accounts at the Fed or because checks written on U.S. banks are being deposited, the T-accounts are identical to that described for Treasury deposits with the Fed. Therefore, an increase in foreign and other deposits leads to a decline in the monetary base.

Other Liabilities and Capital Accounts Suppose a bank has just joined the Federal Reserve System and buys the required amount of stock in the Fed, raising the capital accounts at the Fed. Its deposits at the Fed will be reduced by the dollar value of the stock, and reserves in the banking system will decline by this amount. Therefore, an increase in other liabilities and capital leads to a decline in the monetary base.

Summary Our analysis of the Fed’s balance sheet identifies nine factors that affect the monetary base. Increases in six factors increase the monetary base (the Fed’s holding of securities, discount loans, gold and SDR accounts, float, other Federal Reserve assets, and Treasury currency outstanding), and increases in three factors reduce the monetary base (Treasury deposits with the Fed, foreign and other deposits with the Fed, and other Federal Reserve liabilities and capital accounts).

The factor that most affects the monetary base is the Fed’s holdings of securities, which are completely controlled by the Fed through its open market operations. Factors not controlled by the fed (for example, float and Treasury deposits at the Fed) undergo substantial short-run variations and can be important sources of fluctuations in the monetary base over time periods as short as a week. However, these fluctuations are usually quite predictable and so can be offset through open market operations. Although float and Treasury deposits at the Fed undergo substantial short-run fluctuation, which complicates control of the monetary base, they do not prevent the Fed from accurately controlling it.

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