Banker to the U.S. Government

In addition to acting as banker to banks, the reserve banks fulfill a

second major function: banker to the federal government. Like business

firms, or even households, the U.S. government requires certain bank-

ing services. Receipts come in and payments continually go out, mostly

in checks, and the two are rarely synchronized perfectly. At times, re-

ceipts exceed payments, and the surplus must be invested. More often,

payments must be made before receipts come in, or payments exceed

expected receipts, and the shortages must be financed for short or long

periods. The Federal Reserve assists either directly or indirectly with

these and similar needs of the U.S. government and with some needs of

federal agencies.

As banker to the federal government, the 12 Federal Reserve banks

and their branches handle the Treasury’s ‘checking account,’ that is, they

handle the Treasury’s tax receipts and expenditures. The most straight-

forward way to handle this account would be for the U.S. Treasury to

deposit in the Federal Reserve banks all tax checks from the public and

to have the Treasury pay all the expenditures of the U.S. government

with Federal Reserve checks, that is, checks drawn against the U.S.

Treasury’s account with the Federal Reserve banks.

Actually, only the second part of this proposition is what really hap-

pens: All payments by the U.S. government are made with Federal Re-

serve checks (paper or electronic). The funds for these checks, however,

are in commercial banks and other depository institutions, where they

stay until needed to support the checks drawn against the Federal Re-

serve account. At that time the funds are transferred from these deposi-

tory institutions to the reserve bank against which the check is drawn.

In other words, all government funds are deposited with private insti-

tutions, which benefit from this arrangement, and not with the federal

government’s federal bank.

Some might conclude that this beneficial arrangement for banks is

the result of lobbying by the powerful banking industry. Actually, there

is no sinister motive; this symbiotic relationship between the public and

private sectors actually improves the conduct of monetary policy because

it gives the Fed better control over nonborrowed reserves. As a matter

of fact, until recently, tax receipts were deposited with reserve banks,

and the Treasury’s expenditures were made by drawing checks on those

accounts at the reserve banks. This procedure, however, caused prob-

lems for the Fed. Treasury deposits with the Fed are one of the ‘other

liabilities’ in the Fed’s balance sheet and, hence, are a technical fac-

tor affecting reserves. Like currency, these deposits are a competing use

of reserves, or a factor absorbing reserve funds. As a result, increases in

Treasury deposits drain reserves from the banking system, reserves that

could otherwise be used to support deposits.

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