What would be the likely effect of completely paying off the public debt?

August 1, 2000

This is an extremely timely question, one that economists are now seriously considering.

A few years ago paying down, or even paying off, the U.S. Treasury debt was pretty much a hypothetical proposition. Yet the $70 and $124 billion budget surpluses in fiscal years 1998 and 1999, respectively, and an even larger surplus projected for 2000, raise the prospects for significant U.S. Treasury debt reduction in the future. Moreover, both the Office of Management and Budget and the Congressional Budget Office project large surpluses beyond fiscal year 2000, assuming a sound economy. The actual and projected surpluses raise the potential that much, or perhaps all, of the outstanding privately held U.S. Treasury debt could be repaid. Repayment would result in important changes for the Federal Reserve, for financial markets and institutions, and for other holders of U.S. Treasury debt.

As your question suggests, paying off the U.S. Treasury debt would have important implications in the financial world. Among those institutions affected would be the Federal Reserve. The Fed implements monetary policy through open market operations buying and selling U.S. Treasury securities. A significant reduction in the size, breadth, or liquidity of the U.S. Treasury market likely would require major operational changes in the conduct of monetary policy. Furthermore, the Fed held over $500 billion in U.S. Treasury securities in its portfolio at the end of 2000-Q1; repayment would require the Fed to hold other assets in its portfolio.

Paying off the privately held portion of the U.S. Treasury debt–$3,182 billion at the end of 2000-Q1–would have important implications for financial markets as well. Financial markets today use U.S. Treasury securities in many ways. Treasury securities set the benchmark risk-free (default risk) interest rate that all other securities are compared against. The broad and liquid U.S. Treasury security market also is used to estimate the yield curve, by comparing interest rates on Treasury securities with different maturities. Market participants already are noting that U.S. Treasury buy-backs in the 30-year bond market have changed the shape of the yield curve.

U.S. Treasury securities also are an attractive liquid asset that is free of default risk. Domestic financial institutions, governments, and investors held $1,908.8 billion in U.S. Treasury securities at the end of 2000-Q1. Repayment of the U.S. Treasury debt would affect how domestic financial institutions and investors hold their assets in the future.

Shifts out of Treasury securities would involve large sums of money. Some of the key financial intermediaries and investors in U.S. Treasury debt that would be affected are shown below.

U.S. Treasury Securities Held by
Domestic Financial Institutions and Investors
Domestic Financial Institutions
Outstanding 1999-Q4
Pension funds
$445 billion
Mutual funds

$351 billion
Depository institutions
$245 billion
Insurance companies
$136 billion
Financial Investments Held By:
State and local governments

$267 billion

Savings bond investors

$187 billion

Finally, foreign and international holders of U.S. Treasury debt held almost $1,242 billion, or over 36 percent of privately held U.S. Treasury debt, at the end of 2000-Q1. If U.S. Treasury debt were paid down, the availability of suitable alternative investments to Treasuries would affect how and where these international investors might hold their financial assets in the future. Clearly, repayment of the U.S. Treasury debt would lead to many important changes in financial markets and extend to a wide variety of financial institutions, both in the U.S. and abroad.

Gross Public Debt of the U.S. Treasury
(Billions of dollars, end of period)
Total, by holder
U.S. Treasury and other federal agencies and trust funds
Federal Reserve Banks
Private Investors
Foreign and international
Other holders*

*Includes pension funds, mutual funds, state and local governments, depository institutions, savings bonds, insurance companies, and other miscellaneous investors.

SOURCE: U.S. Treasury Department. Monthly Statement of the Public Debt of the United States; data by holder, Treasury Bulletin. Federal Reserve Bulletin, August 2000, Table 1.41. Gross Public Debt of U.S.Treasury, page A27. See also web site: http://www.fms.treas.gov/mts/

Addendum: The U.S. Treasury Department announced on October 24, 2000, a record $237 billion surplus for fiscal year 2000.