The Role of Government Bonds in the Economy

by Bryan Keythman, studioD

U.S. government bonds, which are also known as Treasuries, are debt securities that the Department of the Treasury sells to investors. Treasuries consist of bills, notes and bonds. An investor pays money to the Treasury Department, which agrees to pay a rate of interest and to repay the money at a set date in the future. Treasuries play a major role in the U.S. economy, such as financing government spending and influencing economic growth.

Government Funding

The government’s budget is generally larger than the amount it collects from tax revenue. Treasuries fill this deficit and act as low-interest loans to help fund the government’s operations. Because the government uses its full faith and credit to guarantee U.S. Treasuries, it pays low interest rates to investors, which saves taxpayers money. This government backing makes Treasuries virtually risk-free, which creates a steady demand from domestic and foreign investors.

Control Money Supply

The Federal Reserve uses U.S. Treasuries to increase or decrease the money supply, which is the money that circulates in the economy. Increasing the money supply can help stimulate the economy, while decreasing it can slow the economy. For example, to increase the money supply, the Federal Reserve buys Treasuries on the open market. Sellers deposit money from the sale in banks, which increases banks’ reserves. Banks with more reserves can loan more money to customers, which can stimulate the economy.

Interest Rate Tool

U.S. Treasuries help control interest rates and inflation, which is the effect of rising prices in the economy. Interest rates decrease when the Federal Reserve buys Treasuries and increase when it sells Treasuries. Lower interest rates for extended periods can lead to inflation, while higher interest rates help reduce inflation. For example, low interest rates create cheaper loans, which give consumers more buying power and prompts businesses to raise prices. The Federal Reserve can sell Treasuries to raise interest rates and limit inflation.

Safe Investments

Because the federal government insures bank accounts in the United States only up to a certain amount, U.S. Treasuries are the safest way to store large amounts of money. State and local governments, pension funds and individual investors buy Treasuries with money they don’t immediately need and cannot risk losing. For example, a state government with $100 million in excess cash might buy $100 million in Treasuries, earn a small amount of interest and sell them when it needs the money.

About the Author

Bryan Keythman has performed stock investment research and writing for a consulting firm since 2008. He also has prior experience sourcing and underwriting commercial real-estate investment and development opportunities for a commercial real-estate developer. Keythman holds a Bachelor of Science in finance.

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