The Treasury And The Federal Reserve

By Lisa Smith AAA

The U.S. government has a vested interest in the health and welfare of the country's economy. Read on to find out how the Department of the Treasury works hand in hand with the Federal Reserve to maintain economic stability.

The Department of the Treasury
The Department of the Treasury, established in 1789, is the older institution. While the Department of the Treasury is perhaps best known for its role in collecting taxes and managing government revenue, its official mission is to "serve the American people and strengthen national security by managing the U.S. government's finances effectively, promoting economic growth and stability and ensuring the safety, soundness and security of the U.S. and international financial systems."

To accomplish its mission, the Department provides economic advice to the president and works with other federal institutions to "encourage global economic growth, raise standards of living and to the extent possible, predict and prevent economic crises." The Department of the Treasury is also responsible for printing currency and minting coins. (For further background reading on the U.S. Treasury, see What Fuels The National Debt?)

The Federal Reserve
The Federal Reserve System was established in 1913. It serves as the central bank of the U.S., with a mandate to "keep our money valuable and our financial system healthy." Its primary method of accomplishing this task is through its influence on monetary policy. (To learn more, read Formulating Monetary Policy.)

This effort involves ensuring that lenders and borrowers have access to money and credit. It also involves balancing the access to money through adjustments to the discount rate and federal funds rate in order to keep inflation in check. (To learn more about the Federal Reserve, see our Federal Reserve tutorial and How The Federal Reserve Was Formed.)

Working Together
Managing Government Funds
The Department of the Treasury and Federal Reserve work together in an effort to maintain a stable economy. The Federal Reserve serves as the government's banker, processing transactions, such as accepting electronic payments for Social Security taxes, issuing payroll checks to government employees and clearing checks for tax payments and other government receivables.

The Federal Reserve and the Department of the Treasury also work together to borrow money when the government needs to raise cash. The Federal Reserve issues U.S. Treasury securities and conducts Treasury securities auctions, selling these securities on behalf of the Department of the Treasury. Examples of Treasury securities include:

The Federal Reserve and the Department of the Treasury are also linked in another way. The Federal Reserve is a nonprofit company. After their expenses are paid, any remaining profits are paid to the Department of the Treasury. The Department of the Treasury then uses that money to fund government spending. It's a relationship that produces a considerable amount of money. The Federal Reserve System contributed in excess of $29 billion to the Treasury in 2006, according to the Federal Reserve Board (FRB). So, the Federal Reserve not only helps to make and implement policies, it also serves as the government's bank and generates a portion of the revenue used to fund the country's activities.

Fighting Recession
When times are tough, the two entities help to formulate and put in place economic policies designed to stimulate the economy by reducing interest rates and making more money available to banks and consumers. (Read more in The Federal Reserve's Fight Against Recession.)

When a decision is made to issue tax rebates, the Department of the Treasury is responsible for taking money out of the Federal Reserve and putting it into the hands of consumers. Consumers, in turn, spend the money. Through their spending, they funnel money into the economy, resulting in increased sales of consumer goods and increased employment to create those goods.

Bailing Out Companies
The Federal Reserve and the Department of the Treasury can also work in concert to help support government-sponsored enterprises, such as Fannie Mae and Freddie Mac. When these entities run into financial trouble, the Federal Reserve can provide access to funds at a discounted borrowing rate, while the Department of the Treasury can increase the line of credit that it makes available and even purchase stock in the entities. (For further reading, see Fannie Mae And Freddie Mac, Boon Or Boom?)

The assistance they provide can also be extended to non-governmental corporations. The near collapse of investment bank Bear Stearns in 2008 is one such example. Officials from the two entities loaned around $29 billion in taxpayer funds to facilitate JP Morgan's purchase of Bear Stearns. While the U.S. government initiated the bailout as a Federal Reserve-led action, any losses incurred would come out of the Treasury's funds. Similar government-sponsored bailouts of non-governmental corporations took place in the airline industry in 2001, the savings and loan industry in 1989 and at Chrysler Corporation in 1979. (For further reading about Bear Stearns, see Dissecting The Bear Stearns Hedge Fund Collapse.)

Partners in Protection
While the Federal Reserve and the Department of the Treasury are separate entities, they work closely together. The partnership seeks to take action at the macro level, for example, by addressing economic weakness through economic stimulus, and at the micro level, by saving failing corporations to blunt the impact their financial troubles would have on the economy. In this way, both entities seek to protect the economy of the U.S.

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