by Edward Flaherty (last updated September 6, 2000)

Myth #8: If it were not for the Federal Reserve charging the government interest, the budget would be balanced and we would have no national debt.  

A popular misconception about the Federal Reserve is that it has something to do with the national debt.  The argument is that because the government must pay interest on the money it has borrowed over the years, today's budget deficit is higher than what it would otherwise be.  If only the Fed wouldn't charge interest on the debt, the government would not have a deficit.

Several things make this argument wrong.  First, the Federal Reserve holds very little of the national debt.  Of the $5.7 trillion in government bonds currently outstanding, the Fed holds only about 8.7%. 2   This means that the bulk of the interest payments go not to the Federal Reserve, but to the other bondholders.

Second, nearly all the interest paid to the Federal Reserve is rebated to the Treasury.  This means that the bonds held by the Fed carry no net interest obligation for the Treasury.  For example, in 1999 the Fed collected $28.2 billion in interest on its portfolio of government bonds, but it rebated $25.4 billion to the Treasury.1

Third, to say that the budget deficit would be smaller but for the interest payments is an exersize in absurd logic.  One could just as easily say that the deficit is caused by defense spending, Medicare, or any other combination of programs with spending that sums to the amount of the budget deficit.  One could also blame Congress for not raising enough taxes to cover their spending plans or for spending too much in the first place.

Finally, placing blame for the national debt at the door of the Federal Reserve demonstrates an ignorance of how our government works.  The national debt has but one cause: Congress.  The debt is the sum of all the budget deficits and budget surpluses the federal government has ever had.  It is Congress, not the Federal Reserve, that determines federal spending and tax rates.  Therefore, it is Congress, not the Federal Reserve, who is responsible for it.

References:

1. 86th Annual Report of the Board of Governors 2. Treasury Bulletin, June 2000, p.49.
 

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