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.