[...] The House version of the bill, instead of diverting dividends, proposed employing this surplus capital, which today amounts to $29.3 billion, to cover new expenditures on highways and transit. [...] The compromise version of the bill that passed both houses caps the Fed’s surplus capital at $10 billion, with the remaining being passed to the Treasury [...]
With no actual money in the surplus capital account to begin with, the Fed can only reduce the account in one of three possible ways. The most straightforward would be for the Fed to create $19.3 billion of new base money for the Treasury to spend. In the first year, surplus capital would be run down to $10 billion, with $19.3 billion of Fed deposits and currency on the same side of the balance sheet ultimately replacing this fall in capital.[5] The total on each side of the balance sheet would remain unchanged. The Congressional Budget Office estimates that future increases in the capital of member banks will require the Fed to continue funneling between $2 and $3 billion of “surplus capital” per year to the Treasury. Because this method increases the money supply and is mildly inflationary, the Fed will more likely sterilize the transfer in two other ways discussed by Ben Bernanke in a blog post criticizing the House plan.
One of these alternatives would involve the Fed immediately selling off $19.3 billion of Treasury securities and transferring the proceeds from those sales to the Treasury. This would reduce the Fed’s total balance sheet on both sides by the same amount, but keep the monetary base roughly unchanged, sterilizing the transfer. But since the Treasury securities sold are now owned by the general public rather than the Fed, the Treasury no longer receives Fed remittances for the interest paid on this portion of its debt. What the Treasury has gained in one lump sum it now looses in the form of future income from the Fed, with the present value of both approximately the same. In short, with no new revenue or increased taxation, the Treasury’s new transportation expenditures will merely increase government deficits.
The Fed could instead cover its payment of $19.3 billion to the Treasury by directly reducing its regular Treasury remittances. In effect, the Fed would still only be giving back to the Treasury what it has first received from the Treasury in the form of interest payments. Again, the Treasury will lose approximately as much as it gains. Recall that in 2014, total Fed remittances to the Treasury came to $97 billion. So all the Fed would have to do is reclassify $19.3 billion of its future excess earnings as a payment from the surplus capital. To simultaneously reduce the surplus account to $10 billion without selling off any assets, all the Fed needs to do is move $19.3 billion into “other liabilities and accrued dividends.” Ceteris paribus, the balance sheet totals and the monetary base remains unchanged. The additional highway spending will still increase current and future budget deficits.
The Fed will probably use some judicious mix of all three methods to comply with the new requirement. [...]
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