Money and Capital Markets 19 C h a p t e r Eighth Edition Financial Institutions and Instruments in a Global Marketplace Peter S. Rose McGraw Hill / IrwinSlides.

Money and Capital Markets

1919C h a p t e r

Eighth Edition

Financial Institutions and Instruments in a Global Marketplace

Peter S. Rose

McGraw Hill / Irwin Slides by Yee-Tien (Ted) Fu

The Treasury InThe Financial MarketsThe Treasury InThe Financial Markets

2003 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw Hill / Irwin

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Learning Objectives

To examine the many important roles played by the government’s Treasury Department.

To identify how the government raises new funds and how it spends the funds raised.

To understand how the activities of the Treasury Department impact the money and capital markets and the economy.

To explore two key government policy tools – fiscal policy and debt management.

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Introduction

The U.S. Treasury Department exerts a potent impact on the financial system through its

fiscal policy – the taxing and spending programs of the federal government designed to promote various economic goals, and

debt management policy – the refunding or refinancing of the federal government’s debt in a way that contributes to its economic goals and minimizes the debt burden.

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The Fiscal Policy Activities ofThe U.S. Treasury

Congress dictates the amount of funds the federal government will spend each year on programs like welfare and national defense, and also determines the sources of tax revenue and tax rates.

When tax revenues are not sufficient to cover expenditures, a budget deficit occurs.

A budget surplus occurs when government revenues exceed expenditures.

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The Fiscal Policy Activities ofThe U.S. Treasury

Federal GovernmentRevenues, Expenditures, and Net Budget Surplus/Deficit

-500

0

500

1,000

1,500

2,000

1961 1966 1971 1976 1981 1986 1991 1996 2001

FiscalYears

$ Billions

Receipts

Outlays

Surplus or Deficit (-)

Data Source: U.S. Office of Management and Budget

The Fiscal Policy Activities ofThe U.S. Treasury

Source: U.S. Office of Management and Budget

Federal GovernmentRevenues, Expenditures, & Net Budget Surplus/Deficit

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The Fiscal Policy Activities ofThe U.S. Treasury

Recent Tax and Expenditure Legislation The Economic Recovery Tax Act (1981) aimed to

simulate savings and business investment in order to reduce inflationary pressures in the economy.

The Gramm-Rudman-Hollings Balanced Budget and Emergency Deficit Control Act (1985) mandated reduced budget deficits.

The Economic Growth and Tax Relief Reconciliation Act (2001) was designed to encourage the public to save more.

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The Fiscal Policy Activities ofThe U.S. Treasury

Effects of Government BorrowingBorrowing from the nonbank public

higher incomes, spending, and interest rates

Borrowing from depository institutions no change in the money supply or total reserves;

total income, spending, and interest rates rise

Borrowing from the Federal Reserve banks money supply increases; total reserves are

unchanged, but excess reserves fall; total income, spending and interest rates rise

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The Fiscal Policy Activities ofThe U.S. Treasury

Effects of the Retirement of Government DebtRetiring debt held by the nonbank public

lower incomes, spending, and interest rates

Retiring debt held by depository institutions no change in the money supply or total reserves;

total income, spending, and interest rates fall

Retiring debt held by Federal Reserve banks money supply decreases; total reserves are

unchanged, but excess reserves increase; total income, spending and interest rates fall

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The Fiscal Policy Activities ofThe U.S. Treasury

The conventional view of government borrowing adding to income and possibly driving up interest rates and inflation has been challenged in recent years.

It was pointed out that interest rates and prices may not rise if an equal amount of private borrowing and spending are crowded out, or if the added government borrowing has already been anticipated and discounted by the market.

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Management of the Federal Debt

Corporations, commercial banks, and other institutional investors rely heavily on government securities as a readily marketable reserve to be drawn upon when cash is needed quickly.

Today, the U.S. public debt is the largest single collection of securities available in the financial system.

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The Size and Growth of the U.S. Public Debt

0

1,000

2,000

3,000

4,000

5,000

6,000

1901 1921 1941 1961 1981 2001

$ billionsThe U.S. Public Debt

Data Source: Bureau of the Public Debt

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The Size and Growth of the U.S. Public Debt

On a per capita basis, the U.S. public debt amounts to more than $20,000 for every man, woman and child living in the U.S.

How did the federal debt become so large?

Wars, economic depressions, and the rapid expansion of military expenditures and social programs have been among the principal causes.

Source: Bureau of the Public Debt

19 - 14The Composition of the Public Debt

Investors in U.S. Government Securities19 - 15

Data Source: Treasury Bulletin, Department of the Treasury (U.S.)

Investor Group Dec 2000 Jun 2001

Federal Reserve & Government accounts … 2,781.8 3,004.2

Privately held: Depository institutions ……………………… 198.9 190.1 U.S. savings bonds …………………………… 184.8 185.5 Pension funds Private ……………………………………… 137.7 127.5 State and local governments ……………… 195.7 197.1 Insurance companies ………………………… 110.2 94.8 Mutual funds ………………………………… 312.5 333.2 State and local governments ………………… 236.2 216.5 Foreign and international …………………… 1,201.3 1,167.4 Other investors ……………………………… 303.1 210.5

Total privately held …………………………… 2,880.4 2,722.6

Total public debt ………………………… 5,662.2 5,726.8

(In billions of dollars)

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Methods of Offering Treasury Securities

Treasury debt managers are called on continually to make decisions about raising new money and refunding maturing securities.

They must decide what kinds of securities to issue, which maturities will appeal to investors, and the form in which an offering of securities should be made.

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Methods of Offering Treasury Securities

The auction method is the principal means of selling Treasury notes, bonds, and bills today.

Examples of auction methods used include the yield auction, uniform price auction, and “reverse auction.”

Today, the marketable public debt is issued in book-entry form only .

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Methods of Offering Treasury Securities

New Treasury bills, notes, and bonds can be bought directly from the Treasury Department or from the Treasury’s agents – the Federal Reserve banks.

Many investors also place orders for new Treasury issues through a security broker or dealer, bank, or nonbank financial institution.

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The Goals of Federal Debt Management

Housekeeping goals pertain to the cost and composition of the public debt, such as minimizing interest costs and reducing the frequency of refundings.

Stabilization goals relate to the impact of the debt on the economy and the financial markets.

The goal of economic stabilization often conflicts with other debt management goals.

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The Impact of Federal Debt Management

Most experts agree that in the short run, the financial markets become more agitated and interest rates tend to rise when the Treasury is borrowing.

There is also some evidence that lengthening debt maturities increases long-term interest rates relative to short rates.

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The Impact of Federal Debt Management

However, most authorities are convinced that the debt management activities of the Treasury do not have a major impact on economic conditions.

The effects of debt management operations appear to be secondary compared to the impact of monetary and fiscal policy on the economy and the financial markets.

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Money and Capital Markets in Cyberspace

Find out more about the Treasury by visiting: http://www.treas.gov/ http://www.publicdebt.treas.gov http://www.treasurydirect.gov/ http://www.imf.org/external/np/mae/pdebt/2000/

eng/ http://www.iga.ucdavis.edu/

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Chapter Review

Introduction The Fiscal Policy Activities of the U.S.

Treasury Sources of Federal Government Funds Federal Government Expenditures Recent Tax and Expenditure Legislation Effects of Government Borrowing on the Financial

System and the Economy Effects of the Retirement of Government Debt

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Chapter Review

Management of the Federal Debt The Size and Growth of the Public Debt The Composition of the Public Debt

• Marketable Public Debt• Nonmarketable Public Debt

Investors in U.S. Government Securities Methods of Offering Treasury Securities The Goals of Federal Debt Management The Impact of Federal Debt Management on the

Financial Markets and the Economy