In the wake of the Great Recession and recovery, Ylan Q. Mui of the Washington Post wrote a provocative piece arguing for the Federal Reserve and the Department of the Treasury to actively collaborate, a break from the Fed’s traditional independence. Now in the wake of the coronavirus pandemic, Mui’s idea has been realized as the Treasury Department and Federal Reserve worked together in an unprecedented way to secure loans and money for individuals and businesses alike.
The cooperation between the Federal Reserve and Treasury Department during these unprecedented times is unique in its strength; however, there is tension in Washington right now over whether it should be maintained or pulled back. The current Treasury Secretary Steven Mnuchin has tried to restrict the relationship between the Fed and Treasury by limiting the Treasury funds available to the Fed — even asking the Fed to return unused Treasury funds. In contrast, once Janet Yellen starts as Secretary of the Treasury, she most likely will seek to strengthen the relationship between the Federal Reserve and Treasury, and create a new standard for cooperation between these two institutions.
After the onset of the coronavirus pandemic in March 2020, Congress passed the coronavirus relief bill, which empowered greater collaboration between the Fed and the Treasury. The coronavirus relief bill designated $500 billion for the Treasury to use for COVID-19 relief, with $454 billion specifically appropriated for the Treasury to invest in the programs established by the Federal Reserve. As thousands of corporations and businesses faced liquidity and solvency issues, the Federal Reserve stepped in with emergency lending programs such as the Main Street Lending Program using money funded by the Treasury.
The U.S. rarely sees this type of explicit collaboration between the Treasury and the Fed. The Fed has traditionally sought to maintain its independence from the rest of Washington in order to conduct monetary policy without political influence. This independence has played a critical role in controlling inflation. Throughout the Korean War, President Truman wanted the Fed to keep interest rates low to make financing the war cheap despite already increasing inflation. The autonomy of the Fed ensured the Fed would not keep interest rates artificially low, which would spur the economy to a point where prices would rise too quickly and uncontrollably. A similar situation occurred in the 1970s under Jimmy Carter, when then-Fed Chairman Paul Volcker kept interest rates high despite political pressure from Washington. He too prevented runaway inflation and extreme currency devaluation.
The funding from the Treasury Department has played a critical role in the Fed being able to support the U.S. economy, especially during the coronavirus pandemic. The Fed does not like taking losses on its balance sheet because it looks as though the Fed is trying to support failing businesses instead of trying to keep markets functioning. The inflow of money from the Treasury allows the Fed to make loans it might not otherwise make and also provides political cover. Funding from the Treasury indirectly sanctions the riskier loans, meaning that the Fed is less likely to come under political attack if the loans are not repaid.
The importance of the Fed receiving money from the Treasury is apparent. However, there has been tension between current Treasury Secretary Steven Mnuchin and current Fed Chairman Jerome Powell over what to do with unused funds. As of November 2020, only $25 billion of loans and other assets have been funded, leaving $429 billion in excess Treasury Funds. In a letter Mnuchin wrote to Powell on November 19, 2020, Mnuchin requests that the Federal Reserve return these unused funds as he believes markets have responded positively and banks were able to continue lending with the support from the Fed. Some programs will see renewed funding after December 31, 2020, such as the Commercial Paper Funding Facility, Money Market Mutual Fund Liquidity Facility, the Paycheck Protection Program and the Primary Dealer Credit Facility, but the other lending facilities will not.
Mnuchin writes that as a law the coronavirus relief bill is only intended for short-term funding, and the unused money must be returned to the Treasury in order for Congress to make the decisions about how to spend the leftover funds. For the other programs, Mnuchin is not trying to stop aid to business all together, but rather trying to reign in the relationship between these two institutions. Given that this type of lending between the Treasury and Fed is unprecedented, it makes sense that there is a fair amount of uncertainty over just how closely the Fed and Treasury should be working together.
However, if Yellen is the new Treasury Secretary, Congress and the American people could see the relationship between the Fed and Treasury moving in a completely new direction. If Janet Yellen is confirmed by the Senate, she most likely would seek to revive some or all of the Fed lending programs that are set to expire in December. Restoring the lending program requires the approval of the Treasury Secretary and five votes from the Federal Reserve Board of Governors. Under the original agreement of the coronavirus relief bill between the Fed and Treasury, there is a strong legal argument Yellen and the new board would be able to. Additionally, the Treasury must by law give prior approval for any new facility that the Fed creates under its emergency lending authority, and with Yellen as Secretary of Treasury, she will have a major role in their approval process and in shaping the way the lending plays out.
With more direct influence coming from the Treasury, the Fed’s policies will start to reflect Washington political constraints and desires. This raises the question of whether this relationship threatens the Fed’s independence. On one side exists the argument that this type of collaboration is what Congress intended in order to ensure that the policies of the Fed and Treasury do not work against each other, such as in 2007 when the Fed tried to lower interest rates by buying long-term debt while the Treasury issued more. The other side sees cooperation between the Fed and Treasury as fiscal irresponsibility, as interest rates may be held artificially low and the Fed will continue to make riskier loans. There is also the question of whether the Fed should continue with these emergency lending programs and for how long.
The next few years will feature policy experimentation as Yellen and a possible new Fed Chair will likely lead a more collaborative approach to Fed-Treasury lending than the previous administration. A new relationship could have wide-reaching economic impacts on the speed of economic growth, inflation, economic stability and jobs. It will affect COVID-19 economic recovery and will continue to affect how the Fed and Treasury respond to economic crises in the future, for better or worse.
Image Credit: “Federal Reserve Building in Washington D.C. – Illustration” by DonkeyHotey is licensed under CC BY 2.0
