Origins of the Use of Treasury Debt in Open Market Operations: Lessons for the Present

From late 1997 through the third quarter of 2001, continuing fiscal surpluses by the federal government caused the outstanding stock of Treasury debt to decrease substantially. While the onset of the current recession, along with the recent tax cuts, has slowed or even reversed this trend, many analysts believe that the declines in Treasury debt will resume over the next decade once the economy starts to strengthen. This could present an operational problem for the Federal Reserve. The Fed currently injects liquidity into the economy by expanding bank reserves via open market operations. That is, the Federal Reserve expands liquidity by purchasing securities on the open market and withdraws liquidity through open market sales of securities. Currently, all permanent transactions by the Federal Reserve open market desk use Treasury securities, and Treasury securities remain the primary medium for temporary transactions. As demand for currency and dollar-denominated bank reserves grows in the years to come, the Federal Reserve will have to acquire ever-increasing amounts of Treasuries via open market purchases. But if the total stock of such securities shrinks over the next decade or two, the Fed may find it increasingly difficult to conduct the needed transactions.