Professor L. Randall Wray on why a government with a sovereign non-convertible currency might choose to issue bonds. Bond sales are not a borrowing operation for the state. Logically, since the dollar is a liability (an IOU) of the government, it’s impossible for the government to borrow back dollars, just like it would be impossible for you to borrow back your own student loan debt, or for Pizza Hut to borrow back its own coupons. Rather, a bond sale is just a swap of one government-issued asset (cash) for another (bonds) which pays interest. It doesn’t change the amount of assets or liabilities out there, only the form.
A government that issues its own non-convertible currency does not need to sell bonds in order to spend. This is because it issues the currency every time it spends (and destroys the currency when it taxes). The main reason such a government might want to sell bonds is because of its effects on interest rates.
If the government is running a deficit, then it is creating more money than it destroys through taxes. This means that the banking system will have excess reserves, more than they need to settle inter-bank payments and meet reserve requirements. Normally, banks don’t want to hold excess reserves, they’d rather purchase some other higher-interest-earning asset.
So they will take the excess reserves and try and loan them to other banks (note that they cannot loan them to the public. That would be impossible, because the public does not have accounts at the Fed, and reserves only exist in accounts at the Fed). The market for interbank loans is called the “Federal Funds market” in the United States. The system-wide position of excess reserves, that everybody is trying to get rid of but nobody wants, will drive interest rates down, potentially to zero.
If the central bank doesn’t want to have a zero overnight interest rate, if they prefer a higher rate target, then they need to drain the excess reserves, and the government does this by selling bonds and destroying the reserves. (And it’s identical whether it’s the Fed or the Treasury doing the selling.)
The government does not need to do this. They could simply leave excess reserves in the banking system, and then have a permanent zero overnight interest rate. Or, they could stop selling bonds, but raise the interest rate by directly paying interest on reserves, because no bank will lend out reserves for less interest than they could get by simply leaving them parked in its Fed account.
So, bond sales are actually part of a monetary policy operation to sustain an interest rate higher than the interest rate paid on bank reserves (which is usually zero). A government might also offer bonds to its citizens if it would like to give them risk-free interest income.
(For a government that manages its exchange rate, such as through a gold standard, the government may be forced to sell bonds in order to maintain the exchange rate peg. This is because savings held in currency is eligible to be converted to the gold or pegged currency, while savings held in bonds is not. So the government can sell bonds to take pressure off of its exchange rate, and prevent it from running out of foreign currency (or gold) reserves.)
See the whole lecture here: https://www.youtube.com/watch?v=i35uB…
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