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As in any bank, operating costs are essentially fixed costs -- what it costs to manage the buildings, shredders, salaries of employees, security, overhead, etc., just like in any other business or government office.  It costs only trivially more to have a portfolio of $1 billion than it does to have a portfolio of $1 trillion, so this means that operating costs are not a relevant consideration for determining the size of a central bank's portfolio.

The Fed is a government arm which earns interest on its portfolio, but it is required to hand over all of its net profits to its real "owner," the US Treasury, so when the Fed owns government debt, regardless of how the Fed ended up with that debt in its portfolio, it is really just the US Treasury owing itself debt and paying itself interest.

That the Federal Reserve Banks technically have "shareholders" is not in any way similar to the way private corporations have shareholders.  The shareholding in the Fed refers to how banks are equitably charged (aka taxed) for the services of being regulated by the Fed and for having access to Fed lending, not to any "shares" in profits or to control over monetary policy in any way. National banks must pay the Fed, partly through a through a membership fee system, in order to be regulated by the Fed.

This means that US federal debt held by the Fed is really not debt at all.  The Fed could just declare that the debt no longer existed and nothing would happen. (And the reportedly high US debt to GDP ratio would fall from something over 90% to around 60%. Another word for this is "monetizing" the debt.) The reason the Fed doesn't do this is the belief that it needs an institutional means independent of Treasury or Congress to quickly take cash out of the financial system if inflation becomes a problem, and it does that by selling its federal debt holdings to the public in exchange for the public's cash, which is simply shredded when it arrives at Fed branches.  (Don't worry, they'll just print more if a bank needs more notes and sells Federal securities back to the Fed in exchange for cash.)

by santiago on Thu Oct 14th, 2010 at 12:46:09 PM EST
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