What is the relationship between the Fed and the Treasury?

Fed and Treasury, who is who, who does what, and how? Or perhaps a tougher question is, what is the relationship between the Fed and the Treasury? To save you some time, if you can answer these questions without hesitating or looking up, do not continue reading! Those of us who simply have a blurry understanding could use this piece as a quick refresher.

The Federal Reserve System (also known as the Federal Reserve or simply the Fed), and the U.S. Department of the Treasury, (referred to as the Treasury), are two pillars of the U.S. economy and financial system. They are distinct and independent entities that function differently but in partnership. The Fed’s role is to conduct monetary policy, and the Treasury’s is to conduct fiscal policy.

This piece is meant to shed some light on these two powerful entities while at the same time attempting to answer the question, what is the relationship between the Fed and the Treasury?

The Central Bank of the United States is the Fed. It was the U.S. Congress that determined the macroeconomic objectives for the Fed to maximize employment and ensure price stability; these are referred to as the Federal Reserve’s dual mandate. Congress also established that the operational conduct of monetary policy should be free from any political influence. The result of this was a Central Bank with independence from the federal government. However, it is Congress that oversees the Federal Reserve System.

How the Federal Reserve operates within the U.S. government framework

A statutory framework established by Congress guides the operation of the Federal Reserve System.

Source: The Fed Explained: What the Central Bank Does (federalreserve.gov)

The Federal Reserve System comprises three key entities, the Federal Reserve Board of Governors, 12 regional Federal Reserve Banks, and the FOMC (Federal Open Market Committee). The Chair of the Board of Governors is the FOMC Chair.

Twelve Federal Reserve Districts operate independently but with supervision

Federal Reserve District boundaries are based on economic considerations; the Reserve Banks in each District operate independently but under the supervision of the Federal Reserve Board of Governors.

Source: The Fed Explained: What the Central Bank Does (federalreserve.gov)

This Central Bank seeks to perform five general functions with the end goal of promoting the effective operation of the U.S. Economy and ultimately serving the public’s interest. These general functions include:

1. Conduct monetary policy
2. Promote stability of the financial system by adjusting the inflation rate and influencing the employment rate
3. Supervise and regulate financial institutions
4. Foster payment and settlement system safety and efficiency
5. Promote consumer protection and community development

In short, the U.S. Treasury is the controlling government department for all federal finances and is responsible for promoting economic growth and security. The department’s umbrella stretches from the Internal Revenue Service, the U.S. Mint, the Bureau of the Fiscal Service, to the Alcohol and Tobacco Tax and Trade Bureau.

The functions of the Treasury can range from printing Federal Reserve notes, issuing bills and bonds,collecting taxes, overseeing the manufacturing of coin and currency, enforcing tax laws, to managing the governments accounts and debt issues. Other activities include advising the President of the United States on economic and financial issues, disbursing payments to the public, and overseeing the borrowing of funds necessary to run the federal government.

It is no mystery that geopolitical risks seem to be at an all-time high in 2022. For example, you may have heard of economic sanctions being implemented on some bad actors from Russia as a result of the Russian invasion of Ukraine. Lo and behold, it is the Treasury Department that performs this critical role, further strengthening national security by implementing such sanctions against foreign threats to the U.S. The Treasury’s arm can go as far as identifying and targeting financial support networks of national security threats.

The Treasury works with international financial institutions, foreign governments, and other federal agencies to encourage economic growth globally and to a certain extent, predict and prevent economic and financial crises.

At the helm of the Treasury is the Treasury Secretary, which is analogous to a finance minister in other countries. The Secretary is the financial agent for the US Government, which is almost like being the CFO of the United States. The primary tasks of the Secretary of the Treasury are to advise the President on economic issues domestically and internationally, and to implement the administration’s economic policies. Fiscal policy refers to the federal government’s spending and tax policies. The Fed plays no role in formulating fiscal policy. It is Congress and the U.S. President’s Administration that determines fiscal policy decisions.

The Fed and the Treasury work together to provide stability in the US economy and to borrow money when the government needs to raise cash. Both entities are key in the Government’s efforts in fighting recessions, as well as partnering in the design and implementation of economic policies to help stimulate the economy.

As previously mentioned, it is the Treasury that is responsible for issuing government debt, but it is the Fed’s responsibility to conduct Treasury securities auctions on behalf of the Treasury. The Fed is also responsible for adjusting the interest rates paid out by these Treasury debt instruments. These interest changes in turn directly affect every other lending rate, ultimately affecting consumers and businesses. Through the adjustment of rates, the Fed can encourage and discourage lending and borrowing activity.

Another example of the intricate relationship between the Fed and the Treasury is that the Treasury stores most of the nation’s gold supply in a vault at the New York Fed. The Fed also serves as the government’s bank and because it is a not-for-profit entity, any profit it generates is paid out to the Treasury. This money in turn is used to fund the nation’s activities.

To summarize, the Fed is a not-for-profit entity that services domestic financial institutions on behalf of the U.S. government. Its decisions and actions are not politically influenced. In contrast, the Treasury is a federal agency who seeks to provide economic advice to the Administration and implement the Administration’s economic policies. While these two entities are separate and independent, both will partner up to address economic weaknesses, always seeking to protect the health of the US economy. So, next time they ask you the question, “what is the relationship between the Fed and the Treasury?”, perhaps you will have a better opening statement than “it is complex”.

Sources:
The Federal Reserve, August 2021. “The Fed Explained: What the Central Bank Does”
Investopedia, January 2022. “U.S. Treasury”
U.S. Department of the Treasury. “Duties and Functions FAQs”
The Federal Reserve, August 2017. “What is the difference between monetary policy and fiscal policy, and how are they related?”
Investopedia, June 2021. “U.S. Treasury vs. Federal Reserve: What’s the Difference?”
CFA Institute. “Monetary and Fiscal Policy”