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The Fed has announced that it is going to purchase $ 600 billion of Treasury debt in order to lower interest rates. How does this work? The Fed gets its money by drawing on a line of credit from Treasury. When there is a budget deficit (as now), Treasury gets its money by issuing debt. So, the Fed buys $ 1000 of Treasury debt, obtaining the money by borrowing from Treasury. Treasury gets the $ 1000 by issuing Treasury debt. This looks like a wash sale, with no reduction in Treasury debt on the market. Bernanke is not stupid. There must be some reason why buying Treasury debt reduces interest rates. Please explain.

2 Thoughts on How does the Fed reduce interest rates by buying Treasury debt?
  1. Reply
    Don G
    November 25, 2011 at 12:37 pm

    When the Fed purchases $ 600 bill of US Treasury securities, it puts more money in circulation, and less US Treasury debt. With less US debt outstanding, the price of the remaining debt increases, following the law of supply and demand. As the price of debt increases, its yield decreases, thereby reducing the cost of debt in the market.

    The Fed doesn’t borrow from the Treasury, it just prints more money to buy the securities.

  2. Reply
    KlemKiddleHopper
    November 25, 2011 at 1:00 pm

    It looked really good – but just remember – Federal Reserve buying Treasury Bond from

    the Federal Government – just taking it out of one pocket and putting it in another –

    with the national debt being so high – those bonds were a terrible investment if

    you could really call it investment

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