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Sort of a follow-up to this question on the Politics SE, which asked about the US government cancelling debt held by China.

From the answers to that question, this kind of selective default is not much better than a full default, because the entity being defaulted on (China in this case) can seize US assets abroad as "payment" for the debt. How would this work if the US government decided to only cancel bonds held by the Federal Reserve? Since the Fed is part of the US government, presumably the government can decide not to seize its own assets (does that even make sense?) or retaliate in any way, and there'd be no consequences other than the fact that there's no more interest payment on debt.

Can the US government selectively default on debt held by the Federal Reserve? If yes, what are the possible consequences? I'm especially interested in economic consequences.

Related: What would happen if the US defaults on its debt? which deals with a wholesale default.

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  • $\begingroup$ The usual discussion is of the Fed cancelling the debt on its own. Don’t have a reference to the discussion, but I think some other posters might have more information. $\endgroup$ – Brian Romanchuk Jan 15 at 0:29
  • $\begingroup$ Fed is government institution so that would be tantamount to US defaulting on itself. All profits from US bonds held by fed go to treasury, save for covering its expenses and dividends to member banks but it’s not like US could function without central bank so those expenses are just part of the cost of running the organization. Only issue here would be that it would encroach on Fed independence so it would be like government ignoring Supreme Court rulings - probably that would create some political trouble but there would be no significant economic consequences. $\endgroup$ – 1muflon1 Jan 15 at 3:44
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The total federal debt equals intragovernmental holdings plus debt held by the public. Technically the federal debt held by the Federal Reserve System (Fed) is considered to be debt held by the public. However by law the Fed covers its operating costs and then returns to the federal government almost all of the interest payments it earns from holding the debt of the federal government.

If Fed is treated as the monetary authority of the federal government, despite its political independence, then the Fed balance sheet can be consolidated with the Treasury balance sheet for the federal government. Note the Treasury keeps an incomplete balance sheet because the value of land and natural resources is not considered in the national accounts.

If one consolidates the Fed and Treasury balance sheet positions then this reduces the debt held by the public by the amount of debt held by Fed. Also it eliminates the Fed liabilities due to Treasury. But it would not reduce the Fed liabilities held by the public. So the public holds a mix of Fed and Treasury liabilities issued to manage fiscal policy and monetary policy on behalf of the federal government.

The federal government issues debt to implement fiscal policy and authorizes Fed to implement monetary policy in large measure by the purchase and sale of Treasury debt in the open market. So there is nothing to be gained in terms of fiscal or monetary policy objectives even if the government tried to cancel debt owed to Fed.

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