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When intra-governmental relations turned sour – the US-Fed Accord – Part 2

In Part 1 of this mini-series – When relations within government were sensible – the US-Fed Accord – Part 1 – I examined the pre-1951 agreement between the US Treasury department and the US Federal Reserve Bank, which saw the bank effectively fund the US Treasury. The nature of that relationship, which began when the central bank was formed in 1913, changed in 1935 when the legislators voluntarily chose to change the capacity of the currency issuer to buy unlimited amounts of US Treasury debt directly to one of only being able to purchase the debt in the secondary markets once issued. But the effect was the same. The central bank could control the yields at any segment of the bond maturity curve at its will. The shift in 1935 was the result of conservative forces that were intent on derailing the government’s capacity to use the consolidated central bank/treasury to efficiently advance well-being. They wanted political constraints placed on the Treasury, such that it would have to issue debt to the non-government sector before it could spend, which they knew was an arrangement (similar to formal debt ceilings) that could be used to pressure the government towards austerity. By the time the Korean War ensued, these conservative forces were winning the political debate and big changes were to come, which would limit the fiscal capacity of the US government to this very day. The result has been an inefficient fiscal process prone to capture by conservatives and certainly not one that a progressive would consider to be sensible. I analyse that shift post-1942 in this blog, which is Part 2 in the series. In Part 3, we pull the story together and reveal what was really going on.

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