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What’s the Difference Between The Federal Reserve and The US Treasury Dept

What’s the Difference Between The Federal Reserve and The US Treasury Dept

Most of us know the heads of these organizations: Ben Bernanke as the Chairman of the Federal Reserve (Alan Greenspan being his predecessor) and Timothy Geithner as the Secretary of the Treasury (Henry “Hank” Paulson being his predecessor). But it’s not always obvious how each of them is functioning.

The US Treasury Department can be thought of as the book keepers for the United States as an entity. If you think of the United States as if it were a company, it’s a company that gets revenue (mostly in the form of taxes) and has expenses (which can be military expenses, entitlement programs, etc.). They collect revenues through the IRS (Internal Revenue Service) and effectively “pays the bills” of the United States. If the US has more expenses than it does revenue, it puts us at a deficit. In order to raise the money to pay for this deficit, the US Treasury will use US government debt instruments (such as bonds, notes and bills). In addition to this, the Treasury prints and mints all paper currency and coins in circulation through the Bureau of Engraving and Printing and the US Mint (which has operating facilities in Philadelphia, San Francisco, Denver and West Point). This is why you will usually see Timothy Geithner testifying before Congress when it has to do with deficits, the debt ceiling, or taxes (think “revenue”). This is also why we saw his predecessor Hank Paulson involved in the government bailouts (as it was going to involve a government expense).

The Federal Reserve is a newer entity that was created in 1913 after a series of financial panics (particularly the severe one in 1907). The general purpose of the Federal Reserve is to stabilize prices, maximize employment and moderate long-term interest rates. A key way that they do this is by lowering and increasing the “Fed Funds Rate” (which is the rate that a great deal of lending is based on). If the economy is sluggish, they will lower the rate to make it cheaper for borrowers to get money. This flood of money into the market acts as an economic stimulus and (hopefully) keeps prices stable. Also this stronger demand for goods should keep employment numbers under control. Conversely, if the economy heats up and there is too much money chasing too few goods then it can cause prices to go up (inflation) and the Fed may increase interest rates to choke out the money supply. They have additional tools to control money supply such as setting the amount of money banks must have on reserve and controlling other interest rates such as the “Discount Rate”. In terms of controlling monetary policy, the Federal Reserve is in currently in uncharted territory. They have pushed rates down as low as they are able and have been doing new tactics meant to stimulate the economy such as Quantitative Easing (called QE1 and QE2). These are programs that have been over-simplistically called “the Fed printing money” or more appropriately called the “Fed expanding its balance sheet”. This is where the Fed buys back various bonds in order to remove toxic assets off balance sheets (such as during the Savings and Loan Crisis) or to buy mortgage backed bonds to drive lending costs down. To do this, the Fed electronically creates money (they are not literally printing money). Because of these responsibilities, this is why you’ll usually see Ben Bernanke testifying before Congress when it comes to economics and stimulating the economy.

There are additional nuances of these institutions, but at a minimum it should serve to distinguish the two from one another.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance referenced is historical and is no guarantee of future results.

 

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