Let's say the Federal Reserve purchases a \$100 one-year Treasury bill from the market, and puts ~\$100 of cash into the economy. A year later, this T-bill comes due, and the Treasury pays the Fed $100. What happens with this cash?
I can imagine a few possibilities:
- The money is immediately reinvested in new securities. Since no new money is created, the monetary base stays constant.
- The money is destroyed, shrinking the monetary base.
- The money is transferred to the Treasury as Fed revenue. Since this money (a Fed liability) is no longer backed by a security, the Fed's balance sheet goes into the red.
This question is motivated by this quote from the Wikipedia page on Debt Monetization:
The central bank may purchase government bonds by conducting an open market purchase, i.e. by increasing the monetary base through the money creation process. If government bonds that have come due are held by the central bank, the central bank will return any funds paid to it back to the treasury. Thus, the treasury may "borrow" money without needing to repay it. This process of financing government spending is called "monetizing the debt".
This seems to imply the third of my listed possibilities, but as mentioned this seems to break the promise that all Fed-issued money is backed by assets.