Chris Russo on Existing Fed-Treasury Tensions and Potential Solutions for Fixing Them

Chris Russo is a Monetary Policy Program Research Fellow at the Mercatus Center at George Mason University and has previously worked at the New York Federal Reserve Bank. He joins Macro Musings to talk about the work he is doing on tensions between the Fed and the Treasury’s management of their respective balance sheets. Specifically, David and Chris discuss what these tensions are and what fixes can be implemented to ameliorate the existing plumbing issues.

Read the full episode transcript:

Note: While transcripts are lightly edited, they are not rigorously proofed for accuracy. If you notice an error, please reach out to [email protected].

David Beckworth: Chris, welcome to the show.

Chris Russo: Thanks for having me, David. Really excited to be here on the show and at Mercatus.

Beckworth: Yes. Glad to have you on board as well. As many listeners may know, the Monetary Policy Program at Mercatus Center started off with Scott Sumner, then I joined. And we have a support staff, as you know Chris, but now you're the most recent scholar to join in.

Beckworth: Of course, we do commissioned papers we've had, for example, Peter Conti-Brown, Miles Kimball, Josh Hendrickson, Bob Hetzel write papers for. So, we do a lot of outsourcing. But you're now the third in-house scholar we brought on board. And we're bringing you on board because we want someone to work on the plumbing of monetary policy, and the big questions about balance sheets and money markets and all those interesting things that are obviously becoming more and more important as we've seen over the past few years.

Beckworth: So, we are so excited to have you on board and we want to hear about your work. We want to hear about your journey into all of this, your time at the Fed. So, why don't we begin with the very basic question that I often ask my guests, how did you get into economics and ultimately into monetary economics?

Russo: First, let me say, David, I followed your work and Scott's work for several years now. And so, I'm excited to be rounding us out as the third scholar for the Monetary Policy Program. For me, I've been fascinated by economics ever since I was really young. I know some kids get interested in music or sports, normal things. I was drawn into macroeconomics and history. So, as a kid and a teenager, I read a lot.

Russo: One book that stuck with me was *A Monetary History of the United States* by Friedman and Schwartz. This was their massive tome on the history of money and banking in the U.S. since the end of the Civil War, up until about 1960. Their conversation about the Depression, in particular, stuck with me where they were talking about, in their view of the Fed's failure to set monetary policy correctly, either caused or deeply exacerbated the Great Depression.

Russo: And in their narrative, the protagonist is a guy named Ben Strong, who's the Governor of the Federal Reserve Bank of New York. And then they're telling, had he not prematurely passed away, he could have averted the Depression by setting monetary policy appropriately. So, as a teenager reading that, and being convinced by Friedman's arguments, I, one can really appreciate how important economics and monetary policy is. But more than that also gained an appreciation for the importance of having the right leadership and the right decisions being made, particularly in times of crises. So, how did I get into economics? I mean, I've carried that line of thinking with me through my career, and I've been really excited and privileged to have the opportunity to work at the Federal Reserve.

Beckworth: So, let me ask how old were you when you read that book?

Russo: I was precocious, I was probably 14 or 15.

Beckworth: Wow.

Russo: It was formative.

Beckworth: Wow. Let me just say I was forced to read that book in grad school. And you're right, the Great Depression chapter is interesting. But there's a lot of data and these descriptive details, which doesn't make for very engaged reading. So, I'm pretty impressed that as a teenager, you read that. That was the last thing on my list as a teenager.

Russo: Well, for anybody out there who might be interested, I just recommend reading the footnotes. For whatever reason they, shove all the right details into the footnotes.

Beckworth: Okay. Yeah, that's a great book. It's a classic, and any monetary economist worth their salt should at least claim they've read some part of that book. Kind of like we all claim you've read some of Adam Smith's *Wealth of Nations*, the great book that defined our profession.

Russo: I have to read it again when I was at Rutgers taking a course with Mike Bordo, who is student Friedman's and Schwartz's.

Beckworth: Yeah, Mike Bordo. Great. He's been on the show too, great monetary historian. Oh, that's great. So, you've had Mike Bordo as a professor, in fact, we're going to learn soon, you've met a lot of interesting people along your journey. So, you read the New York Fed before you came to us, so we're glad to steal you away from them. Tell us some of what you did there. What was your job at the New York Fed?

Experience at the New York Fed

Russo: I wore a lot of hats at the Fed, and at the New York Fed in particular. At a high level, I was doing model building, forecasting and advising policymakers, in particular about balance sheet issues. So, really, there were maybe two strains of work that I was doing. The first strain was about the balance sheet overall, trying to forecast what it would look like over the next decade, say. And advising policymakers about the likely consequences of their decisions on the balance sheet as well as on income.

Russo: This was during a time especially during policy normalization or balance sheet normalization, started back in 2017, where policymakers began to ask more detailed questions about what the composition and other criteria for the balance sheet look like over time. So, that was some areas I did a lot of work in. In addition to that, I worked on forecasting the TGA, or the Treasury General Account. That's the Treasury's cash account of the Fed, that's going to play I think, an important role in the conversation we're having. And the TGA, as you might imagine, is of interest both the Fed and Treasury policymakers. The Treasury, of course, wants to make sure they have enough cash on hand to meet their obligations.

Russo: And because the TGA is such a large and volatile component to the Fed's balance sheet, liability side, they're interested to know what that will look like both in the short term on a daily frequency as well as over the longer term. I would say that one of the highlights of my time with the New York Fed was running the forecast for the debt limit episode that we had in 2019, when we needed an idea of when in the absence of an increase in the debt limit, or resuspension of the debt limit, Treasury would not have enough money on hand to meet its obligations. And that was just a stressful, but really great experience for me to have to, well, produce that forecast and to have the opportunity to try to convince President Williams and his Executive Committee of that forecast and have, I hope, an important useful role in that decision making.

Beckworth: So, you were in the Markets Group at the New York Fed, is that right?

Russo: That's right. Markets Group, and in particular on the open market trading desk.

Beckworth: Okay.

Russo: That's a group of people who actually implement monetary policy. Most economists and people more broadly, understandably, don't think about that. They usually say, oh, the Fed said, it's a target rate, whatever the band is. These are the people who actually go out and make sure that it's being met. With the floor system, as you know, that's not a day to day concern, necessarily, but more broadly thinking about asset purchases, thinking about the functioning of financial markets more broadly.

Beckworth: Yeah. So, the New York Fed is the front line of the Federal Reserve in the marketplace. You're the face of the Fed, when you're buying and selling securities, when you're doing all these facilities we did last year. New York Fed is the one that implements them. And you were a part of that. So, you interacted with Lorie Logan, for example, did you have any work with her?

Russo: I did. I was, again, really privileged to be able to write a memo ahead of each FOMC meeting for her and Simon Potter about my projections for the balance sheet. So, as you might imagine, Simon and Lorie, very busy people, so it's hard to get face time. But where I was able to, I had a great time doing work for them.

Beckworth: So, Chris, walk us through for all people here curious, what is the typical day in the life of a market desk economist like yourself? You get up in the morning, walk us through your day. I know, not every day is the same, but if there is a typical day, what would it be like?

Russo: My day was probably a little bit unique, particularly since I spent a lot of my time working out of Chicago instead of in New York proper. They have a group of us out there in the Chicago Fed building just for contingency planning purposes, so that we're always able to operate in the markets if need be. So, I said about, maybe 75% of my time in Chicago, about 25% of my time in New York and elsewhere on the east coast.

Russo: Each day, I would wake up, get into the office, depending on what I had to do, maybe 6:00 or 6:30. That was important because we had a 9:00 a.m. Eastern Time conference call. So, excuse me, let me get the time zones, right. That's 6:00 my time out in Central Time Zone needed to get into a phone call with Treasury and people around the system at 9:00 to show my daily TGA forecasts.

Russo: That took decent amount of time in the morning, of course. And then for the rest of the day, it was a relatively relaxed working environment, to be honest. Being more of an economist or quant, I was a few feet away from the people actually making trades. So, I got to focus on doing model building, statistical testing, those sorts of things, and we'd have meetings throughout the day to report findings to other people on the desk, as well as senior policymakers have one, ending, I work quite a lot. So, my day is not necessarily indicative, but usually maybe hitting out at 6:00 or 7:00.

Beckworth: Okay. So, is it true that our vision of a typical Fed economists, they got the best data, the best software, when you had your own Bloomberg Terminal, all that good stuff?

Russo: That's true, that's definitely true. One of the perks of the job, Bloomberg Terminal, as well as, lots of lots of great data.

Beckworth: Yeah, I bet. Data that many people outside the Fed would die to get their hands on. So, I had to ask this, Chris, you mentioned earlier that you were listening to the show for some time. So, we can say, "Hey, Chris, was someone at the New York Fed, he listened," but anybody else listening at the New York Fed, do you think, to the Macro Musings podcast?

Russo: I know they are. I know they are. Two good friends of mine, at least on my team at the New York Fed are listeners. I believe others are as well, let me withhold names, but I'll just say that I'm looking forward to the text messages I received from the podcast, when it goes live.

Beckworth: Okay. So, this is a shout out to all of Chris's friends at the New York Fed. And look, I know there's other people listening as well. I've had very senior Fed officials come up to me and mentioned things I've said. I've had people reach out to me and actually contest things I've said on here. So, it's great to hear though the frontline economists also get a chance to engage and listen.

Russo: I could say, at least I appreciate the show, because you're really hitting a new market. It's different from the Chicago style academic paper talks where people yelling at each other for about an hour or about some arcane part of the metrics versus the more public facing, we're going to explain the basics of economics. So, I really appreciate the hit of middle ground.

Beckworth: Well, it's been great. Now I got to tell the story, then, Chris, when I first came to Mercatus, Tyler Cowen, your boss too, and then Dan Rothschild, our operational boss a step below Tyler. Those are our two bosses. They took me out to eat, it's 2016. And I said, "Hey, I have an idea for a podcast on macro policy." They looked at each other, looked at me and they said, "Beckworth, that will only ever get about five episodes in it. We don't see a market for it."

Beckworth: And I think what they were thinking is, David wants to talk about nominal GDP targeting and we'll get tired of it after five episodes. I said, "No, no, no, no." There's just so much that's unsettled. There's always something new as we're going to talk about today. You mean, Treasury balance sheet issues, there's always something new, always something fresh to be discussed. And that's proven out to be the case, for sure.

Beckworth: So, all right, so you've had a great run at the New York Fed, we stole you away, you're now on our team, you're doing work. And you have a paper that you're working on, called *Toward a Modern Treasury-Fed Accord.* And this paper is a great paper. Again, it touches on some of the plumbing issues that we want to expand our program to cover. So, why don't you give us the fundamental problem you're trying to address in this paper

Three Tensions Between the Treasury and the Fed

Russo: Certainly. The fundamental problem that I'm trying to address is the fact that since 2008, changes to Treasury policy and Fed policy have resulted in really tight tensions between the two institutions, not personal tensions, of course, but I'm speaking in terms of the policies that they are pursuing for monetary policy limitation at the Fed and sovereign debt management at the Treasury. In my view, it's a lot like a tug of war, where they're pulling each other in opposite directions. And I want to, in the paper, highlight what I think the contentions are, and propose a set of reforms, akin to the 1951 Treasury-Fed Accord to help resolve those differences, or at least to reconcile them in a way that I think is more sustainable.

I want to, in the paper, highlight what I think the contentions are, and propose a set of reforms, akin to the 1951 Treasury-Fed Accord to help resolve those differences, or at least to reconcile them in a way that I think is more sustainable.

Beckworth: And so, just to build upon what you said just a few minutes ago, this is a topic that you saw firsthand, right? This is something that you experienced in your job. So, you firsthand saw this tension and said, "Hey, I want to have the chance to sit down and write about it," is that fair?

Russo: That's exactly right, that's exactly right.

Beckworth: All right. So, you outline three tensions in this paper that you see is troubling, that need to be resolved. I'm going to read them to you, we'll do work one by one down the list. And the first one is, “Treasury seeks to finance the debt at the least cost over time by increasing the average maturity of government debt, while the Fed shortens it to ease financial conditions.” So, explain that tension to me, and why is it consequential?

Russo: Sure. So, Treasury wants to finance the deficit at the least cost of the taxpayer over time. They can't control the path the deficit or the overall level of debt, but they try to issue debt either short term or long term to minimize expected cost. But at the same time, the Fed is purchasing now a tremendous amount of Treasury securities. Effectively, that's an asset swap. It's swapping these long dated securities for reserves, which are effectively instantaneously maturing and floating rate, hence, have no interest rate risk.

Treasury wants to finance the deficit at the least cost of the taxpayer over time. They can't control the path the deficit or the overall level of debt, but they try to issue debt either short term or long term to minimize expected cost. But at the same time, the Fed is purchasing now a tremendous amount of Treasury securities. Effectively, that's an asset swap. It's swapping these long dated securities for reserves, which are effectively instantaneously maturing and floating rate, hence, have no interest rate risk.

Russo: So, that's one way in which the Treasury and Federal pulling each other in opposite directions over the average maturity of government liabilities. I think that both are trying to do it for good reasons. Not only is Treasury trying to get at least expected costs, but the Fed, at least according to their statements, and the conversations I've had with people, are trying to, one, create financial stability. And maybe we'll talk a little bit about what's happened in the last year, two years that would make these purchases possibly necessary, but also to ease financial conditions, so that we have a stronger recovery. So, that's one way at least in which I think the policies are in contention.

Beckworth: So, did you discuss this while you're at the New York Fed, the idea that the Fed is trying to effectively shorten the maturity of the outstanding public debt. I mean, go back to QE2, QE3, for example, the argument is we're going to take out these Treasuries, this is going to affect interest rate long term yields, some substitution effect, maybe people go look into riskier assets. But at the same time there were all these critiques of QE policy.

Beckworth: Well, look, you're fighting against the Treasury. The Treasury is bigger than you are. It's going to produce more debt than you're going to pull out. How effective is QE? And there was this conversation that we were having, we've had on the show, in fact, many times if people want to question the efficacy of QE, given that this tension going on. Was this debate that you saw at the Fed as well?

Russo: So, I more so saw this debate when it came to the long run composition of the balance sheet and the purchases required to get there. And I think this has been emphasized in the statements of policymakers publicly as well. What should our purchases look like, so in the long run, we are neutral? My question was always neutral with respect to what? I think the Fed is conscious. I mean, I speak on behalf of the Fed. I, working at the Fed and in conversations with friends, understood that, I think per Congress, the Treasury ultimately should have responsibility over the maturity structure of government liabilities. The Treasury has been around a lot longer than the Fed has, as much as maybe, my institutional bias makes me a little bit shy to admit that. They've been around since the founding of the country.

Russo: And since that time, the Congress has given them greater and greater independence about financing the deficit. So, I think the notion of neutrality when it comes to the Fed's purchases and long run competition is something that people are thinking about a little bit less relevant now that we're no longer in a policy normalization phase. But it's something that I think is a question for the longer term.

Beckworth: Yeah. No, I've had Peter Stella on the show. He gives the example of Chile, where half of the public stock is actually been issued by the central bank and half by the Finance Ministry. So, it creates some confusion in markets. What is the true long-term bond? Is it the central bank's security, or is it public financing? It does make sense that you'd want to have one institution be the master of managing public debt, and it has been Treasury. So, the concern here is, I guess in the limit, the Fed buys up so much. It can make it a tough job to manage the maturity, the composition of public debt. And the Fed doesn't mean to do this, but unintentionally, it ends up there if it keeps buying more and more securities. That's the concern, right?

I think per Congress, the Treasury ultimately should have responsibility over the maturity structure of government liabilities. The Treasury has been around a lot longer than the Fed has, as much as maybe, my institutional bias makes me a little bit shy to admit that. They've been around since the founding of the country. And since that time, the Congress has given them greater and greater independence about financing the deficit. So, I think the notion of neutrality when it comes to the Fed's purchases and long run competition is something that people are thinking about a little bit less relevant now that we're no longer in a policy normalization phase. But it's something that I think is a question for the longer term.

Russo: Yeah. I mean, it worked really well in the last decade as interest rates stayed low relative to what expectations were. Because the Fed's interest rate expense commensurately was low, increasing remittances to Treasury. That's the ultimate way in which this process works. But I also don't want to just look at this from one perspective. I also want to think about it from the Fed's perspective, where if they're trying to stimulate the economy, dig us out of recession much faster than otherwise, but at the same time, Treasury is introducing a lot more interest rate risk into the market.

Russo: If the Fed's going to offset that, they've got to do even more asset purchases, ballooning the size of their balance sheet and making what you might think of is the per dollar effectiveness of LSAPs much lower. So, I don't have a stand here today to share about whether I think or how effective I think LSAPs are. But to the degree that they are effective, they're less effective on a per dollar basis, if the Fed is fighting against the tide of Treasury. In my view, that I argue in the paper, is that effectively at the zero lower bound, there is this tight tension here, particularly when the balance sheet is already quite large.

Beckworth: Okay. So, tension one, just to repeat is that Treasury and the Fed are pulling in separate directions on the maturity of the debt, both for good reasons. Let me throw in an academic question, all right. So, this is, I don't mean to throw you off track here, Chris, but this is what we do in the podcast. So, the premise of your tension and release the premise of probably the standard view out there is it's great to go long. In fact, last President, last Secretary, I should say to the Treasury, had thought about doing a 50-year bond or longer.

I don't have a stand here today to share about whether I think or how effective I think LSAPs are. But to the degree that they are effective, they're less effective on a per dollar basis, if the Fed is fighting against the tide of Treasury. In my view, that I argue in the paper, is that effectively at the zero lower bound, there is this tight tension here, particularly when the balance sheet is already quite large.

Beckworth: And it makes sense, go long, lock-in these long rates, finance some great endeavor. But there is a critique, and maybe it's a minority view that maybe we should finance everything short term. And I've shared with you this paper that was done publishing the AER about how these authors went and studied Bank of England, and also the Finance Ministry there.

Beckworth: And even they showed over a long, long period, it would have been cheaper for the United Kingdom to have financed its deficit short term, than going long term. Even though in certain moments like today, it seems you can walk in really low rates, because the short end is lower. On average, you can get a better deal, better financing costs. Any thoughts on that? I mean, that maybe we shouldn't be going long, maybe at least a cost-effective way is not the long end, but maybe it's the short end.

Russo: Now that's a question that I get a lot about, but I don't take a stand on the paper. I try hard in the paper to where I can assume the consensus view of policymakers at the Treasury and the Fed. I think it's going to be hard enough to convince them of the reforms that I'm going to put forward. Because it's hard to convince smart people of anything, right? They're naturally very skeptical.

Russo: But I also don't want to try to do too big of a lift. So, my view in the paper, and I think this is a reasonable approximation, is that the people at Treasury are smart, they think about this stuff a lot and very hard. So, to the extent that they're already making issuance decisions to lead to least costs, those decisions are approximately correct. But of course, as you say, people have argued that they could get a better deal by issuing shorter, by issuing longer. There's an interesting literature there that my paper doesn't touch on, but I think there's an important and complementary question.

Beckworth: Yeah, no, it's, again, another academic question, maybe for another podcast, another time. But it's an interesting question to think about, what is the best way for government to finance itself? And as I mentioned to you before the show, Milton Friedman argued this view in 1948, which is pretty radical, where he ended up but he thought that all deficits should be financed with money, that there should be no bonds in the limit.

Beckworth: Okay. Well, let's move on from tension one. Again, tension one is the Fed and Treasury, their balance sheets are moving, the maturity of the public debt stock in different directions. And that creates these tensions, makes it tough, as a country to think about how we manage the public debt. Okay, tension number two, you state, the Fed seeks to economize, in the long run, the size of the balance sheet, while Treasury practices since 2008 have dramatically increased the balance sheets size. So, walk us through that. What does that mean?

Balance Sheet Tug-of-War and the Treasury General Account

Russo: Sure. Policymakers at the Fed, and the New York Fed, in particular, have emphasized that the long run size of their balance sheet is driven by what they call autonomous factors. These are liabilities outside of the control of the New York Fed's trading desk, things like the TGA. That's the Treasury's General Account or checking account at the Fed. We're providing these non-reserve liabilities as a kind of social service, so that Treasury has access to the cash it needs, in order to make payments and receive payments. And for a variety of other reasons that I don't want to go down a rabbit hole into. But their ultimate argument is that insofar as they're just meeting the public's demand for these special types of money, they can't control the long run size of their balance sheet. That's what's driving it.

Russo: And what I argue in the paper is that since 2008, the TGA in particular, has dramatically grown in size. Prior to 2008, and for several decades, as a matter of fact, at least, the Treasury and Fed targeted a $5 billion cash balance in the TGA. The purpose of that $5 billion target was so that payments and receipts for Treasury didn't affect the aggregate level of reserves in the banking system. If you increase the level of the TGA, meaning that the public makes a payment to Treasury, like a tax payment, that drains reserves in order to increase TGA balances. The balances have to add up. The balance sheet has to balance, of course.

What I argue in the paper is that since 2008, the TGA in particular, has dramatically grown in size. Prior to 2008, and for several decades, as a matter of fact, at least, the Treasury and Fed targeted a $5 billion cash balance in the TGA. The purpose of that $5 billion target was so that payments and receipts for Treasury didn't affect the aggregate level of reserves in the banking system.

Russo: And conversely, when the Treasury makes payments to the public, and that decreases level of the TGA, that increases the level of reserves. And now as the TGA has gotten much more larger and much more volatile over the past decade, those swings in TGA commensurate with the swings in reserves are much larger. To give you a sense of scale, again, $5 billion target for the TGA prior to 2008, in the subsequent decade, it grew up to about $300 to 400 billion on average. And in 2020, due to issuance and a buildup of cash balances that was precautionary in response to COVID, balances rose to a high of about 1.8 trillion. And now is coming back down as the pandemic hopefully recedes.

Beckworth: Yeah. And so, this goes back again to your job at the Fed, you have 1.8 trillion. It's come down a little bit since then. But your job was to forecast that, right? And that's a huge swing, as you mentioned, is that thing drains reserves to go up and vice versa. So, if the Fed is trying to think, what's the amount of reserves consistent with our framework?

Beckworth: And you got these big swings outside your control, that' pretty reckless, almost. It makes it really hard. It gives you bad dreams at nighttime, right, as the forecaster for the TGA or alternatively you have a TGA forecast and you're way off because there's this big swing that maybe Congress changed their mind or something. So, yeah, forecasting 1.6, 1.7 trillion is a lot different than forecasting 5 billion.

Beckworth: So, forecasting, Chris, is a hard job and it's particularly hard for the Fed to do and plan if you've got swings that range in the trillions of dollars. Now, tell us, is this swinging consequential beyond just making your job harder at the New York Fed. Isn't it tied to the September 2019 repo event? Can you walk us through the connection here?

Russo: I think so. I think so. And I mean, as much as I like to make the job of myself and my friends at the Fed easier, it's not really the driver behind the paper. I think that there really are consequences here for the broader financial markets as well as for monetary policy implementation. To give you one quick anecdote about the type of forecast miss you might have. I was running the forecast back in the tax season, it must have been April or around April 15th, after the tax reform bill passed with the prior administration.

Russo: And as I recall that tax bill allowed for the onshoring of profits by corporations, and they would pay what I imagined as a special rate compared to what they would normally pay. Because then that would lead to an increase in corporate tax receipts on that particular day, I had to make a guess about what the level of those taxes would be. And I had no good information. So, I made a guess. And I was exactly out of money. I still can't believe it. It was just luck. But you can imagine that other forecasts would not have been so lucky.

Russo: And since we're talking about on that particular line item for the TGA, a difference potentially of several tens or hundreds of billions of dollars, it's hard to offset that in terms of open market operations if you need to have a certain level of reserves to meet the interest rate target or to be in the target range. So, I think you're exactly right to link this back to September 2019. And I tried to do so on the paper. I again, was running the guess forecasts for the debt limit at that time, or just for that.

Russo: My concern on the desk was that Treasury's cash balances had run so low, that at rapid rebuild and balances accompanied by a great amount of issuance would possibly sink us back down to a level of reserves that was below the minimum required to run a floor operating system. So, there were a few things going on here, of course. One, cash balances got really low in the debt limit. Two, in order to rebuild that, a lot of issuance had to go on from the Treasury. And three, the level of reserves was elevated. And so, the sudden drop possibly would bring us back down through the quote, unquote, "minimum of reserves."

My concern on the desk was that Treasury's cash balances had run so low, that at rapid rebuild and balances accompanied by a great amount of issuance would possibly sink us back down to a level of reserves that was below the minimum required to run a floor operating system.

Russo: If I'm being favorable myself, I think that happened. I don't want to deal with them that happened. But something did seem to break into September of 2019. And it resulted in the end of balance sheet normalization. So, I care a lot about the Fed's policy, making sure it's the right policy, and to make sure it's well-communicated. And I worked a great deal to try to help that process along when they were undergoing balance sheet normalization. So, it's telling to me that this type of problem in the repo market, or the financial markets more broadly, brought that process to a close.

Beckworth: Yeah, the way I have seen it portrayed is just what you've said, that the Fed was doing QT or shrinking the balance sheet. So, it was itself pulling reserves out trying to get down to the smallest balance sheet consistent with its operating framework. And no one knew for sure exactly where that was, because I think there were key reason, the Fed didn't know is because of all of these new regulations, banks wanted to hold more reserves, it's a guessing game.

Beckworth: They're feeling their way in the dark to the limit that could go before you trip back into something like a corridor or something else. You fall outside the floor system. But then on top of that, you had all this movement with the tax receipts coming in, on the TGA growing, so it was a perfect storm of events that came together. So, it was a TGA question is the Fed shrinking its balance sheet, everything comes together and boom.

Beckworth: It was a plumbing issue. At the end of the day, it wasn't as if the U.S. was insolvent, or anything else like that, or the Fed lost any power. It's just a plumbing issue. But this plumbing issue, and we've seen it, we saw it in September 2019, I believe March last year, the larger and larger the stock of public debt grows, seems to magnify these problems. It seems to be more and more pronounced. And then looking forward doesn't seem it's going to get any better. So, it is important that we wrestled with them now, right? It's important that we get to the bottom of it, and that's what your paper is trying to do.

Russo: I think so. Certainly, I don't want to say that my paper is the end all be all or I propose a set of reforms that we'll talk about a little bit later in the show. They're complementary to many of the other ones that have been talked about but I see this as one of the pressing issues at least in terms of monetary policy of our year and maybe the next few years.

Beckworth: And just to flesh out this point, again, tension two, someone in your position pre-2008 had it much easier, just to really repeat this point, because the TGA balance was smaller. So, maybe it was easier, not as easy, but easier than what you had to face. Because the TGA balance was smaller, and both the Treasury was committed to this, and the Fed had the understanding of this.

Beckworth: And the Fed, I shouldn't say the Fed contributed to this as well, because the Fed had a corridor system, which meant fewer reserves. So, it was less of an issue in the first place. And the Treasury wanted to support what the Fed was doing. But then you go 2008, and you get to a floor system and you have a floor system, all bets are off now. It doesn't really matter what happens to the level of reserves, once you have an ample amount. And it gives the green light to the Treasury. But what you're saying is above and beyond that, the Treasury's gone wild at the TGA. And maybe that's an exaggeration gone wild. But the Treasury itself has really amped up the TGA account, unlike anything before.

Russo: That's right. And I wouldn't use that descriptor. Let me say that they are raising the balances in the TGA and what they've communicated to the public, because they feel they need these precautionary balances. So, that if they have a loss of market access, they can continue to make the payments that they're required to make by Congress. So, that'd be social security, or payments on the national debt.

Russo: What I will say, though, is that prior to 2008, when there was that limit of $5 billion on the TGA, they would not just only have $5 billion, they would have a much larger amount of money in the private banking system in a process called TT&L, Treasury Tax, and Loan Program. And that TT&L program allowed them to earn a rate of interest on their excess cash balances that even the TGA, and even allowed for them to conduct repo both overnight in term with private counterparties. And that program, I don't know if it's even technically ended, but let's say that it fell into disuse following 2008, particularly after the introduction of interest on excess reserves.

Russo: Because each dollar that Treasury keeps in the private banking system is an additional dollar of reserves. That's good from the perspective of managing the level of reserves in the system, because payments to Treasury or from Treasury don't affect the aggregate level of reserves. But if there's each dollar in the TT&L system, additional dollar of reserves, that means that per who loosens the Treasury doesn't receive interest from the Fed, on its account remit, if did it would all wash because Treasury gets the remittances from the Fed anyway, that it was no longer economical for Treasury to keep balances in TT&L. Because each dollar reserves again would incur a charge equal to IOER.

Beckworth: Yeah. So, just to flesh that out. Every dollar in a bank somewhere that belongs to Treasury is a dollar that earns interest on reserves. And the Fed's profits at the end of the year has to be sent back to the Treasury. And the more they pay out to banks, the less they pay out to Treasury. So, in terms of revenues flowing into Treasury makes sense to pull them out.

Beckworth: That's a great point. So, 5 billion really doesn't get the whole story. It's everything that it had elsewhere in the banking system. And I had George Selgin on, man, maybe a year or two ago, he mentioned historically, this is not the first time this has happened, I believe in the '70s. And maybe it was another decade, but we had this problem before where the TGA had these wide swings, made life very difficult for the Federal Reserve, and they reached an understanding what they would do, including the use of this private banking system.

Beckworth: And you're calling back to that understanding and let's do something different. Okay. So, second tension again is, the Fed seeks to economize on the long run size of the balance sheet, while Treasury's practices since 2008 have dramatically increased the balance sheet size. So, the Treasury is making it very hard for the Fed to be as careful as it can be with the size of its balance sheet. All right, let's go to your third tension then. And that is the Fed seeks control over their monetary policy operating system while the Treasury practices since 2008 have effectively locked the Fed into the floor system.

Fights Over the Fed’s Operating System

Russo: Let me say at the outset that, at least according to the Fed's announcements from what must have been a year or two ago at this point, with COVID time. It's hard to have a good sense of how long ago things really were. But they came out and they announced, in part that they wanted to keep the floor operating system. Something that they had started to do temporarily in 2008 in response to the crisis and other actions they had to undertake, now wanting to be permanently. So, I want to be clear that what I'm arguing here is not that the Fed would necessarily want to return to a corridor system, if they were able to. I'm arguing that as things currently stand with the whole constellation of policies that are in place, I'm concerned that the Fed couldn't exit to a corridor if they ever wanted to. The best explanation, the best illustration of this is may be September 2019.

Russo: Well, of course, the Fed wasn't trying to return to a corridor system. They were trying just to economize on the long run size of their balance sheet, but volatility in the level of TGA balances, an extreme amount of volatility certainly. But nonetheless, volatility in TGA balances reduced the level of reserves to a level that was inconsistent with the floor operating system. My argument is that if they were to try to do a corridor system today, that same volatility would make it very difficult, if not impossible. And these historical norms that the Fed and Treasury have come to use at least for 2008, were a key part of why they were able to run the corridor as they did.

I want to be clear that what I'm arguing here is not that the Fed would necessarily want to return to a corridor system, if they were able to. I'm arguing that as things currently stand with the whole constellation of policies that are in place, I'm concerned that the Fed couldn't exit to a corridor if they ever wanted to. The best explanation, the best illustration of this is may be September 2019...My argument is that if they were to try to do a corridor system today, that same volatility would make it very difficult, if not impossible. And these historical norms that the Fed and Treasury have come to use at least for 2008, were a key part of why they were able to run the corridor as they did.

Beckworth: So, remind me again, I know we mentioned the TGA is sitting around 2, I'm sorry, 1.6, 1.7 trillion. But isn't there a target they have set up that was at 150 billion that they want to hit. So, even if they run it low, still going to be quite a bit larger than the 5 billion before 2008?

Russo: That's exactly right. I want to make sure I get the dates here right when things were officially announced. So, I believe it was 2015 that the Treasury came out and officially announced that they would aim to hold one week of outflows, what we call in the Fed or at the Treasury of five-day need in the TGA. Again, that's just to make sure that if they lose access to markets temporarily, they can make all the government's payment obligations.

Russo: So, that five-day need is generally quite a lot larger than $150 billion, or at least at its maximum that is. But there is that $150 minimum nonetheless. So, if the projected five-day need falls below $150 billion, then nonetheless still hold $150 billion dollars. As a consequence of receipts, and spending and financing close not always wanting on the same days, actually, the five-day need can be quite elevated above $150 billion. So, the general average level of TGA balance is in the last several years prior to the COVID pandemic, when balances were dramatically increased for precautionary reasons, was about $300 to 400 billion. That, of course, much larger than the pre-crisis $5 billion to sometimes $7 billion in times of large tax inflows.

Beckworth: Okay. So, even if the Fed were to take to heart, the preaching of George Selgin, myself and others to go back to a corridor system, which I know they won't, but in some make believe land, it would be very difficult. I mean, it's simply very difficult, given the size of the TGA be very difficult. There would be huge swings in reserve balances. So, the interest rates would be bouncing all over the place, right?

Beckworth: It'd be hard to keep it within some target range like what Canada has, for example, the Bank of Canada's corridor system. So, what you're suggesting is, look, Beckworth, look, Selgin, there's some big hurdles here to clear and the huge TGA account is one of them. Fair enough. Okay. So, we've talked about the tensions. Let's move to your solutions. And it's interesting, your solutions, as I understand it, are premised on the idea that they could be done just with an agreement between the Treasury and the Fed.

Solutions to Fed and Treasury Tensions

Russo: That's exactly right. I was careful in writing the paper, that I only talk about things that could be agreed to in principle between lunch with Secretary Yellen and Chairman Powell. I know they have a great working relationship. And I want to be able to solve the issues that we're talking about without having to appeal to a complicated legislative process or something else, like a presidential commission.

Russo: I, like you and many others, are concerned about the independence of the Fed, I want to keep it independent. And to the extent that we can use the existing legal and regulatory machinery to solve these problems, I lean towards just using that machinery. And to be clear, when the reforms I'm going to talk about in the show with you and that I have in the paper, I think about this more as a meta level point, as opposed to something that's object-oriented.

Russo: And what I mean by that is, in the paper, I'm not arguing that we should go for a corridor system or for a floor system, I'm not arguing that we should go for a shorter maturity of debt or a longer maturity of debt. I'm not arguing that we have a small balance sheet or a large balance sheet. But I do argue, though, is that there are certain institutional norms and responsibilities that are properly the Treasury's and properly the Fed's.

Russo: And there has been a blurring of lines since 2008. And part of the reasons why we're seeing what we're seeing now in the financial markets, I think, is because of that blurring of the lines. And the reforms are, like the 1951, Treasury-Fed Accord that led to the independent Federal Reserve that we know today would again center right these institutional bounds allowing for cooperation where appropriate as before, but nonetheless, making sure the Fed is ultimately in charge of monetary policy, and the Treasury ultimately in charge of sovereign debt management.

I, like you and many others, are concerned about the independence of the Fed, I want to keep it independent. And to the extent that we can use the existing legal and regulatory machinery to solve these problems, I lean towards just using that machinery....I'm not arguing that we should go for a corridor system or for a floor system, I'm not arguing that we should go for a shorter maturity of debt or a longer maturity of debt. I'm not arguing that we have a small balance sheet or a large balance sheet. But I do argue, though, is that there are certain institutional norms and responsibilities that are properly the Treasury's and properly the Fed's...And there has been a blurring of lines since 2008. And part of the reasons why we're seeing what we're seeing now in the financial markets, I think, is because of that blurring of the lines.

Beckworth: Okay. So, it's a meta framework that sets the norms.

Russo: Yeah.

Beckworth: So, without getting too caught up in the details, but nonetheless, you do have some suggestions. So, let's start with reform one, joint target for the maturity structure of government's consolidated liabilities. Explain what that means and how it would look in practice.

Russo: Sure. Again, it goes back in the issue of neutrality that I hear a lot of Fed policymakers talk about and that I thought a lot about, that Friedman wrote a lot about in monetary history, at least a decent amount. What does it mean for the Fed's purchases of the Fed's portfolio to be neutral? I think that, at least, according to the statements of policymakers of both Treasury and the Fed, they care about interest rate risk.

Russo: Treasury thinks about it in terms of trying to minimize expected costs. The Fed thinks about it in terms of their asset purchases and trying to lower term premium. So, when I say that the Fed and the Treasury, as you said, a joint maturity target for government liabilities, I mean that they should stop pulling in opposite directions. If Treasury thinks that the maturity structure of government debt should be something, and the Fed disagrees, they should talk about it, instead of just acting independently, and trying to pull the maturity structure wherever they want it to go.

If Treasury thinks that the maturity structure of government debt should be something, and the Fed disagrees, they should talk about it, instead of just acting independently, and trying to pull the maturity structure wherever they want it to go.

Russo: I don't think that's worked out really well over the last decade. It might be that there may be a balance of considerations. But I suspect that Treasury and Fed policymakers have similar interest in the balance of those considerations. In the sense that, in the long run, I think, the people generally recognize that the maturity structure of government debt isn't properly in the billet of the Treasury.

Russo: On the other hand, when we're at the zero lower bound, and we need additional policy accommodation, to the extent you think that LSAPs work, it's reasonable to run a lower maturity of government debt to give that stimulus. If you care about, say, a debt to GDP, a faster recovery, GDP is going to do a lot more for your expected cost over time, than trying to tinker on the edges about exactly what the maturity structure looks like. So, that's the first reform, have cooperation between Treasury and Fed officials on what the maturity structure of public debt looks like, and the way I think about that as in terms of the target, that maybe varies over the business cycle.

Beckworth: Well, walk us through that. So, say, for example, we're in a normal time. So, no boom, no busts, everything's full employment. We're in a great moderation period. Let's go back in time, great moderation period, all right.

That's the first reform, have cooperation between Treasury and Fed officials on what the maturity structure of public debt looks like, and the way I think about that as in terms of the target, that maybe varies over the business cycle.

Russo: Right.

Beckworth: How does this framework work in that period?

Russo: The framework works in the following way. Again, I'm taking as assumption that the consensus view of Fed policymakers is right, that changes in the interest rate risk held by the public in terms of Treasury debt outstanding affects financial conditions. If we're in normal times, like a great moderation, we're away from the zero lower bound. So, the Fed can offset any changes to the maturity structure of government debt, through changing their policy rate. And so, in that sense, there doesn't need to be any cooperation whatsoever between Treasury and Fed officials. Where this starts to matter is at the zero lower bound, where we need additional monetary accommodation, that monetary accommodation is being prevented from the Fed's point of view, I would argue, by additional issuance of the long term debt.

Russo: So, because I think least in terms of the principles and the norms, this type of decision should ultimately be the responsibility of the Treasury Secretary. I see this as being a target set by the Secretary. The Secretary, in the same way they have to give permission before the Fed does emergency lending under 13(3), they would also say, we're in extraordinary times, we need additional accommodation, we're willing to temporarily forego some of our least cost objectives, at least maybe as narrowly considered, in order to give you the tools you need to stimulate a faster recovery. And over time, the Fed would then undertake asset purchases to ensure that they're not systematically deviating from the desired composition of debt by the Treasury.

Beckworth: Okay. So, during a crisis, when you hit the zero lower bound, the Treasury is much more beholden to what the Fed wants to do in terms of creating lower long-term yields, stoking financial conditions. But in normal times, it would be reversed. The Fed would be out of that business altogether and the Treasury would have free rein to do whatever it wants.

Beckworth: So, I guess the big change and in practice from what we see today, then is you'd see more cooperation, say in 2008, 2009 2010, maybe this last year, where they would talk to each other about what we're going to do with the maturity structure. So, I guess my question is, does that not happen at all now? And how would you, I guess, cause this to happen? What would you say? You'd say, “hey, Chair Powell, Secretary Yellen get together.” I mean, how would you, on the ground, make this happen?

Russo: So, if those conversations are having happening, I'm not privy to them, I'll just say, though, that to my understanding, the purchase decisions being made by Fed officials and the issuance decisions being made by officials at Treasury are made separately. I think it's important, or at least, I could argue that's important, for reasons of independence. I would actually say that this policy becomes more important not in a crisis time like 2007 or 2008, but instead say 2013, 2014 when they're doing these large-scale asset purchases, trying to add additional accommodation, but Treasury were refinancing the longer term.

Russo: That's where I see this being more essential. So, in practice, how does this work? I would really leverage the great relationship between Secretary Yellen and Chairman Powell to set up these new institutional norms. I'm hesitant to prescribe any particular regimen because I don't know what's best for these policymakers and the way they like to negotiate or the way they like to make these decisions.

Russo: What I might recommend, if they're going to have Treasury set a target would be to do it as part of their normal quarterly refunding process. That's the process in which they announced to the public with their intended issuance will be over the next quarter, next two quarters. And in doing so, give the market some idea about how they're refinancing their debt. I think that's a natural place for the Treasury to make an announcement about their intended decisions, including such a target, and the Fed likewise, would be making its asset purchases where appropriate to accommodate that target. I just want to say one thing, I don't think of this as being Treasury beholden to the Fed or the Fed being beholden to the Treasury. In an accord like this, there's nothing stopping either side from deviating from an agreement or from what I'm proposing if they ever did come to agree to it.

I would really leverage the great relationship between Secretary Yellen and Chairman Powell to set up these new institutional norms. I'm hesitant to prescribe any particular regimen because I don't know what's best for these policymakers and the way they like to negotiate or the way they like to make these decisions...What I might recommend, if they're going to have Treasury set a target would be to do it as part of their normal quarterly refunding process.

Russo: Rather, I see this genuinely as benefiting both sides enough that even though it might be uncomfortable for Treasury to be setting such a target, and the Fed to follow it, I think it's in both their interest to do so. And so, I see there's some practicality of this. And likewise, when we move on to the second and third reforms, I think, likewise, it might be a bit uncomfortable for Treasury to follow the Fed's lead, but ultimately it works out well enough for both of them even better than before.

Beckworth: I'll just mention before we move on to the next two reforms you propose, it's interesting you mentioned 2013 QE3. So, the critique back then least from academics, central bankers, of course, thought QE3 worked wonders, but the academic critique was, it's not very effective in a crisis. QE1 packed a big punch, because markets were breaking down. There's this whole Modigliani and Miller or what Michael Woodford and Gauti Eggertsson called the ineffectiveness proposition that QE really doesn't make much difference in normal times.

Beckworth: All you're doing is substituting what would have been done already in the private sector. So, QE1 did make a big difference because markets were cratering and crashing. QE2, QE3 less in bank for the buck, less of a punch, because you're just doing what would have been done anyways. But what you're saying is, well, that being the case, QE2, QE3, we can actually add more oomph to the purchases by having Treasury get on board and complement and support with the Fed's doing. So, that's an interesting maybe way to think about that. But let's move on to number two, reform two, and you say cap the level of the TGA balances. Pretty bold there, Chris, tell us about it.

Capping the Level of TGA Balances

Russo: Bold only if going back to what's been common practice from the TGA-

Beckworth: Fair enough, fair enough.

Russo: ... is bold. Well, I mean, more seriously, I really see this as a common-sense solution in tandem with the third reform we're going to talk about to helping solve some of the dysfunction we see in markets over the last few years. Let's get back to a world where the TGA is not a long run driver, the size of the Fed's balance sheet, and volatility and TGA doesn't cause dysfunction in monetary policy implementation. I see this is as a common-sense thing to do.

I really see this as a common-sense solution in tandem with the third reform we're going to talk about to helping solve some of the dysfunction we see in markets over the last few years. Let's get back to a world where the TGA is not a long run driver, the size of the Fed's balance sheet, and volatility and TGA doesn't cause dysfunction in monetary policy implementation. I see this is as a common-sense thing to do.

Russo: Now, of course, it might not go back down to $5 billion. Again, I'm not trying to argue here that the Fed's balance sheet should be, as small as it was back in 2008, or any particular size. Rather, if the TGA is a long run driver of the balance sheet size, by capping the level of the TGA, whether it's at $5 billion, or something more akin to the current five-day need rule, you instead have a situation that limits that overall acceleration of balance sheet growth. So, I see that as one part of the reform. And, of course, in the same way that I think the Treasury would have, it would be smart to take the input of the Fed when setting a maturity structure target, the Fed would be doing a great practice to have the thoughts of Treasury officials in setting what that cap is to make sure their needs are also taken care of.

Beckworth: Yeah, just worth mentioning here when we're still talking about the TGA, at the end of this month here in March, Chris, you know well that the temporary exemption of reserves and the supplemental leverage ratio, the SLR is going to end. And it's been a lot of buzz, a lot of talk about what's the Fed going to do because you're going to suddenly add back close to $3 trillion reserves in the denominator could really cause bank balance sheets to shrink because then they have to have capital funding to cover that added asset on the balance sheet.

Beckworth: And that's just the reserves over the past year that were exempted, you add those back in. So, there's a lot of concern. It is all, we haven't heard much from the Fed yet. But if you add on top of that, the TGA draining over the next few months, I'm not sure how long, but that's $1.6, 1.7 trillion in additional reserves, I mean that's a huge amount of reserves to force on the bank balance sheets. I mean, so it's not just a question of good monetary policy, it’s banks and how they function and stuff. So, this is a very consequential question. And by capping the TGA may ameliorate these problems to some degree.

Russo: I think so. And certainly, I hope so, just to give some numbers for the audience. Again, the maximum level the TGA last year ended up at about $1.8 trillion, it's come down by about a few $100 billion since then, right now, I think it's at about $1.4 trillion. The level of reserves, actually, despite all of the asset purchases the Fed is undertaking, is still at about its maximum level from before COVID happened back when they were at the previous peak of the size of the balance sheet. So, reserves, at least compared to what they were historically are not yet all that high. But as you mentioned, this upcoming decrease in TGA balances, assuming there's no change to the asset purchase policy at the Fed, or any other balance sheet policy the Fed I should say, will lead to dramatic increases in reserve balances.

Russo: In January, the Treasury announced that they had an $800 billion target for the TGA at the end of March. Those targets are not something they're necessarily wedded to in practice, there are other considerations. But in general, as least as things stand right now, particularly with the $1.9 trillion spending package passed, I think that's a reasonable number. And so, in broad terms, I'm expecting in the next two or three weeks for TGA balances to decline by about $600 billion, that would lead commensurately to an increase in reserves of $600 billion, all else equal.

Beckworth: In a few weeks.

Russo: In a few weeks.

Beckworth: Wow.

Russo: It's massive. And so, as you're pointing out the SLR is very important here. And there's a concern that this additional surge of liquidity could even turn rates negative.

Beckworth: Yeah, that's pretty striking. Okay, so that was reform two, to cap the level the TGA balances. Reform one was a joint target for maturity structure. So, reform three, revive the Treasury tax and note and loan program. We said it again, sound engineer, I mold that. Reform three, revive the Treasury Tax and Loan Program.

Reviving the Treasury Tax and Loan Program

Russo: It's a mouthful of a program, but I think it's very important. So, I call it TT&L. So TT&L is important to make sure that Treasury can have all the cash it needs. Just in the private banking system, like they did prior to 2008. One reason why they had to stop using TT&L, or they chose to stop using TT&L, as I mentioned, was that it become uneconomical for them. The interest rate, the return on those accounts was lower than the interest on reserves, right, the Fed would pay on the additional dollar of reserves.

Russo: So, I propose that they restart TT&L as well as do some administrative rulemaking to update the level of interest they earn on these TT&L accounts to make them more commensurate with market interest rates. For example, like a tie to SOFR, which is the U.S.'s proposed alternative to the dollar livewire rate, to secure overnight financing rate, a broader rate that captures the rate required to borrow in short term repo markets. So, I think that this would just round off the reforms in a way that allows Treasury to continue to meet its cash balance needs, which is not everything at the Fed.

I propose that they restart TT&L as well as do some administrative rulemaking to update the level of interest they earn on these TT&L accounts to make them more commensurate with market interest rates...I think that this would just round off the reforms in a way that allows Treasury to continue to meet its cash balance needs, which is not everything at the Fed.

Beckworth: All right, so we got three reforms. It's in your paper. And this is a paper that will be coming out with the Mercatus Centers. It's a working papers series with the Monetary Policy Program. Chris, in a few minutes we have left, let me just throw at you some other reforms, and ask what your thoughts are. And you can take a pass if you want. But this same question what was considered by others back in, I think the fall of 2019 when we had the repo crisis, what could be done differently.

Beckworth: And I mentioned George Selgin was on the show before and he suggested several things. One would be to have Treasury be able to do “a direct draw authority” that apparently was in existence up until 1981, which is be a way where the Central Bank could buy directly some portion of the new treasuries issued. And, of course, this creates fears of explicit debt monetization. But like the Bank of Canada, every period there's new debt issued, they buy a certain percent of the new debt directly. Its rule bound. That'd be one way to maybe, I don’t know, manage this situation. Do you see this as being helpful? Or is it related in any way to what you see the problem is?

Other Alternative Potential Solutions

Russo: I like George, I think he's a very clever guy from my conversations with him. Let me just say that I think it's outside the scope of the accord that I'm proposing. I try to very narrowly tailor what I'm proposing something that, again, Secretary Yellen, Chairman Powell and the rest of the FOMC come to an agreement on themselves bilaterally, that I think is consistent with the principles and practice of sovereign debt management and monetary policy implementation from the last several decades. Such a director or authority, as you mentioned, existed up until I think, that 1981, and it was led to expire by Congress. So, in my understanding to reinstate that would require the act of Congress. And I am, at this point, skeptical of the importance or the prudence of opening up the Federal Reserve Act again.

Beckworth: Yeah. So, you don't want to tinker with Pandora's box here as what your concern is. Fair enough. Would any of the other proposals out there, that the popular ones that we've talked a lot about on the show, and it's been discussed in the literature and other conversations, but Darrell Duffie's proposal for increased central clearing of the Treasury market, maybe getting a standing repo facility going. Now those two may require more than what you are thinking of here in your framework, but do you see any usefulness of those in dealing with this situation that's driving this conversation?

The proposals I'm putting forward, I try to have it be set up as an accord. So that like the 1951 Treasury-Fed Accord complemented that, not only do we have monetary and fiscal policy working towards separate goals in a complementary way, but the way we implement those policies, monetary policy implementation and sovereign debt management, likewise are working in a complementary way and respecting the history of institutions and norms that I think have served us really well in our country's history.

Russo: I think so. I would treat those as complementary to the set of reforms that I'm putting forward. I’m outside of my scope, again, because I'm thinking about things that require both Treasury and the Fed to cooperate on, things like Treasury central clearing or the standing repo facility. They don't need that level of cooperation.

Russo: But of course, as the problem here or one of the problems here is that, Treasury issuance not only decreases the level of reserves, making it hard for the private sector to intermediate that issuance, but also that there are regulatory constraints on big bank balance sheets, also making it hard from the intermediate the issuance. Then it would make sense, I think, to move to a centrally clear Treasury market. Of course, such a big change would require a lot of study and a lot of work.  So, I don't want to promote that or propose that here now. But things like that or standing repo facility, I think would certainly complement the package of proposals I’m putting out there.

Beckworth: So, Chris, you have some great ideas here. You've identified a problem, you've identified solutions. And the way you frame your paper is in terms of the 1951 Fed Treasury Accord where coming out of World War II and the Korean War, they were closely linked, the Fed had to support Treasury. And it took some pain, some effort, but they finally broke free. They got independence. So, why don't you frame this in a similar light? How can we look to that experience in helping us understand your proposal?

Russo: I think that the two episodes are in parallel, not exactly the same, but in parallel. Of course, before the 1951 Treasury-Fed Accord, the Fed was effectively forced to monetize the debt. And we saw the result of that with very high inflation in the 1940s, year over year, even reaching something like 25%. We're in a different situation now, where now we're worried about disinflation, and not being able to reach the 2% target.

Russo: So, I don't want to claim here that in any way that the Fed is having to monetize the Treasury's debt. What I will say, though, is that like in the 1940s, the Fed has effectively lost control of its balance sheet. Again, we saw that in 2019, when they were trying a process of balance sheet normalization. But a variety of factors, including the ones that I've talked about, led to that being prematurely ended, at least prematurely, in my view. Certainly, ending at a level of the balance sheet much lower than most people expected, it would need to end up to be in order to have a functioning floor system.

Russo: So, the proposals I'm putting forward, I try to have it be set up as an accord. So that like the 1951 Treasury-Fed Accord complemented that, not only do we have monetary and fiscal policy working towards separate goals in a complementary way, but the way we implement those policies, monetary policy implementation and sovereign debt management, likewise are working in a complementary way and respecting the history of institutions and norms that I think have served us really well in our country's history.

Beckworth: All right. Well, with that our time is up. Our guest today's been Chris Russo. Chris, thank you for coming on the show.

Russo: Thanks a lot for having me, David. It's been a lot of fun.

Photo by Karen Bleier via Getty Images