The Government Sector

Like businesses, governments often need to finance their expenditures by borrowing. Unlike businesses, governments cannot sell equity shares; they are restricted to borrowing to raise funds when tax revenues are not sufficient to cover expenditures. They also can print money, of course, but this source of funds is limited by its inflationary implications, and so most governments usually try to avoid excessive use of the printing press.

Governments have a special advantage in borrowing money because their taxing power makes them very creditworthy and, therefore, able to borrow at the lowest rates. The financial component of the federal government's balance sheet is presented in Table 1.6. Notice that the major liabilities are government securities, such as Treasury bonds or Treasury bills.

A second, special role of the government is in regulating the financial environment. Some government regulations are relatively innocuous. For example, the Securities and Exchange Commission is responsible for disclosure laws that are designed to enforce truthfulness in various financial transactions. Other regulations have been much more controversial.

10 PART I Introduction

Table 1.6 Financial Assets and Liabilities of the U.S. Government

Assets

$ Billion

% Total

Liabilities

$ Billion

% Total

Deposits, currency, gold

$ 98.0

18.1%

Currency

$ 25.0

0.6%

Mortgages

76.8

14.2

Government securities

3,653.6

81.9

Loans

182.9

33.7

Insurance and pension reserves

708.2

15.9

Other

185.0

34.1

Other

76.8

1.7

TOTAL

$542.7

100.0%

TOTAL

$4,463.6

100.0%

Source: Flow of Funds Accounts: Flows and Outstandings, Board of Governors of the Federal Reserve System, June 2000.

Source: Flow of Funds Accounts: Flows and Outstandings, Board of Governors of the Federal Reserve System, June 2000.

One example is Regulation Q, which for decades put a ceiling on the interest rates that banks were allowed to pay to depositors, until it was repealed by the Depository Institutions Deregulation and Monetary Control Act of 1980. These ceilings were supposedly a response to widespread bank failures during the Great Depression. By curbing interest rates, the government hoped to limit further failures. The idea was that if banks could not pay high interest rates to compete for depositors, their profits and safety margins presumably would improve. The result was predictable: Instead of competing through interest rates, banks competed by offering "free" gifts for initiating deposits and by opening more numerous and convenient branch locations. Another result also was predictable: Bank competitors stepped in to fill the void created by Regulation Q. The great success of money market funds in the 1970s came in large part from depositors leaving banks that were prohibited from paying competitive rates. Indeed, much financial innovation may be viewed as responses to government tax and regulatory rules.

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