Regarding treasuries, Mr. Sheard is right: there is no reduction in the money supply when the Fed allows any of its $2.4 trillion of treasuries to roll off its balance sheet. The Fed merely debits the government’s checking account by the amount of any maturing bonds.
However, cutting taxes after a big buyer of our bonds walked away is precisely what is happening. The Federal Reserve stopped reinvesting in October and will continue doing so for the foreseeable future. Two months later in December, our representatives passed a massive tax cut.
One big flaw in the discussion about the congressional tax bill is the lack of understanding of the additional revenue from the sale of new government bonds that will be required to fund the government. Such bond sales would result not only from the loss of revenue from the tax cut but also the necessity to sell more bonds to bankroll the government as the Fed reduces its balance sheet.
But the biggest risk is not a spike in interest rates. It is: when the public buys the bonds the Fed sells, money is removed from the economy. In a normal transaction, a bond’s seller would deposit that sale’s proceeds into the seller’s commercial bank. That deposit would remain in the economy and could be used for additional spending. But when the Fed sells a bond, it doesn’t deposit the money; it extinguishes it.