Significant Effects
In 2005, the Federal Reserve held approximately 9% of the national debt as assets against the liability of printed money. In previous periods, the Federal Reserve has used other debt instruments, such as debt securities issued by private corporations. During periods when the national debt of the United States has declined significantly (such as happened in fiscal years 1999 and 2000), monetary policy and financial markets experts have studied the practical implications of having "too little" government debt: both the Federal Reserve and financial markets use the price information, yield curve and the so-called risk free rate extensively.
Experts are hopeful that other assets could take the place of National Debt as the base asset to back Federal Reserve notes, and Alan Greenspan, long the head of the Federal Reserve, has been quoted as saying, "I am confident that U.S. financial markets, which are the most innovative and efficient in the world, can readily adapt to a paydown of Treasury debt by creating private alternatives with many of the attributes that market participants value in Treasury securities." In principle, the government could still issue debt securities in significant quantities while having no net debt, and significant quantities of government debt securities are also held by other government agencies.
Although the U.S. government receives income overall from seigniorage, there are costs associated with maintaining the money supply. Ecological economist, Herman Daly, claims that "over 95% of our money supply is created by the private banking system (demand deposits) and bears interest as a condition of its existence," a conclusion drawn from the Federal Reserve's ultimate dependence on increased activity in fractional reserve lending when it exercises open market operations. Economist Eric Miller criticizes Daly's logic because money is created in the banking system in response to demand for the money, which justifies cost.
Thus, use of expansionary open market operations typically generates more debt in the private sector of society (in the form of additional bank deposits). The private banking system charges interest to borrowers as a cost to borrow the money. The interest costs are borne by those that have borrowed, and without this borrowing, open market operations would be unsuccessful in maintaining the broad money supply, though alternative implementations of monetary policy could be used. Depositors of funds in the banking system are paid interest on their savings (or provided other services, such as checking account privileges or physical security for their "cash"), as compensation for "lending" their funds to the bank.
Increases (or contractions) of the money supply corresponds to growth (or contraction) in interest-bearing debt in the country. The concepts involved in monetary policy may be widely misunderstood in the general public, as evidenced by the volume of literature on topics such as "Federal Reserve conspiracy" and "Federal Reserve fraud."
Read more about this topic: Monetary Policy Of The United States
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