Thursday, 30 January 2014

Governments don’t borrow even when they think they’re borrowing.

Let’s assume a simple economy where money comes in the form of monetary base issued by the government / central bank machine, and in just sufficient quantities to induce citizens to spend at a rate that brings full employment.  No interest is paid to holders of monetary base. We’ll also assume there are no commercial banks: i.e. citizens bank with the central bank.
The “no commercial banks” assumption might sound odd, but in fact when lending to government or paying taxes, final settlement is always done in base money, not commercial bank created money. So that assumption is not unrealistic.
Now let’s assume government wants to make a public sector investment.
Government could attract funds from citizens with a larger than normal stock of money (I’ll call them “hoarders”) and offer them interest. But unfortunately that wouldn’t work. Reason is that the investment spending would increase demand and we’ve already assumed full employment. Thus the extra spending would be inflationary.
So even if government funded the investment with borrowed money, it would still have to raise taxes so as to ameliorate inflation. (A nice illustration of a point often made by MMTers, namely that the purpose of tax is not to fund government, but to control inflation. Actually that MMT point is a bit of an exaggeration, but it’s a nice sort of “exaggeration to make point”.)
Anyway, getting back to the point that government borrowing does not reduce taxation, you could of course argue that hoarders who “lend” to government will then be short of their “rainy day” stock of money and will thus save more so as re-stock with rainy day money. And indeed, if they did save in that way, that would depress demand, which would make room for the extra demand coming from government investment spending.
However, when lending to government, lenders do not really lose access to their savings in that they can sell their government bonds anytime for cash. And assuming any individual hoarder’s need to sell bonds to meet an unexpected need for cash occurs at a random point in time (which it almost certainly does), then the need for that money by one hoarder will be balanced by another hoarder’s desire to buy government debt.
In short, the process whereby governments supposedly borrow to fund public investments is a farce: they can go through the motions of borrowing to fund investments, but the reality is that those investments are funded out of tax.
The only exception to the above argument comes to the extent that government borrowing is funded by foreigners. On the other had if we assume that citizens of country X buy a dollar of debt issued by country Y for every dollar of debt issued by country X and bought by citizens of country Y, then the above argument holds.
But even to the extent that the latter “X and Y” point does not apply, the argument in the above paragraphs, if it is correct, is an almighty dent in the whole idea that government borrowing is a good idea.

P.S. (same day). In Britain, as in other countries, households with anything near average incomes and average net assets don’t normally buy or sell government bonds directly. But in Britain they can easily do so indirectly via “National Savings and Investments”. NSI has about £100bn of depositors money invested in government stock, and has about 20 million depositors.


  1. MMT makes the point that, when government wants to spend money, government can tax, borrow, or create the money needed. Three choices.

    Each choice has an inflationary bias.

    In my view, the inflationary bias is identical for borrowing or creating with the exception of event timing. Inflation comes much later in time if government chooses borrowing as the way to fund new spending.

    This delay is easily seen if we think of borrowing-by- government as an agreement to not spend your money in the near future. With borrowing, government can spend as government desires, and then government can borrow more from the people it just paid.

    Can borrowing be as effective as taxation as a method of preventing inflation? We could debate that question. I expect 'yes' for the near term, 'no' for the long term.

    1. Roger,

      I agree that both “borrow and spend” and “print and spend” are stimulatory and potentially inflationary. But I suggest the latter is more potent per dollar. In the case of the former, government borrows $X, spends $X and gives $X of bonds to those it has borrowed from. So the private sector is up to the tune of $X of bonds. And that’s presumably less inflationary than when it’s up to the tune of $X in cash.

      I’m not sure about your “delay” theory. Though obviously the two options, print and borrow, have the same inflationary effect in the long run if we wait till government bonds mature, and assuming they aren’t rolled over.

  2. Ralph,

    I agree with you.

    I think of lenders-to-the-government and central banks as both providing the same product: money-for-government-spending. The difference is that lenders must first earn the money and accumulate it, but central banks simply "print" the money.

    Printing immediately increases the money supply while borrowing increases the money supply immediately but is accompanied by an agreement to not-spend-the-increase-until-bond-payoff.

    Then, if the bonds ARE paid off, the increase vanishes. The increase only exists so long as the bonds (or the rolled-over successors) exist.

    Macroeconomics is certainly an interesting puzzle!

  3. Nice post Ralph.
    Its a fascinating subject.
    I always think its best to start with the accounting when thinking about this type of thing.
    We will assume 6 things in our framework:
    1) non-banks can only spend bank deposits. I know everything is really settled in reserves but this fact is irrelevant to the real economy

    2) Assume no banks are buying T-bonds with reserves only, causing net bank effects to be created. Its about 3% of T-bonds currently.

    3) Just like Ralph, full employment and output

    4) Whether Govt spending is compensated for by taxing or selling T-bonds. The net effect to bank deposits is zero.

    5) Reserve only deficit spending (no T-bond offset), does in fact net to an increase in bank deposits.

    6) All taxes and T-bonds are paid for by the top 1% of earners domestically and foreigners. And all recipients of bank deposits by way of reserves from the govt spending are in the domestic 99%.

    What can we deduce about the 3 potential methods (T-bonds, reserves only or taxing) for implementing govt spending with the above tautologies as our framework?

    What would the operational channel be that caused more spending between taxing and T-bonds even though the net effect on bank deposits is zero?
    Of course, we would see increased economic activity due to the differing propensities to consume. Bank deposits owned by the 1% are reduced and the 99% increased in either scenario. Of course the T-bonds result in increased financial wealth but not bank deposits. Once those initial bank deposits are used to buy T-bonds, they are gone forever (in the aggregate, and assuming no surpluses).
    Would another potential impact channel be that T-bonds are used as collateral and so lending, which increases bank deposits, rises on the back of the foundation of T-bond wealth?
    Of course any T-bonds or taxes paid by foreigners would aggregate to an increase in domestic bank deposits, to the extant that those foreign held dollars weren't spent domestically, increasing exports. I.e international oil sales etc.
    Ralph, although I agree with your general sentiment in your comment above, because of the accounting, I do question just how great the inflationary difference would be of just spending reserves and thus creating net bank deposits. At the end of the day, I would think the difference was surprisingly small in our experiment. Theoretically, except for the foreign component impact, it would all come down to the propensities to consume.

    1. Auburn,

      "What would the operational channel be that caused more spending between taxing and T-bonds even though the net effect on bank deposits is zero? "

      I liked your comment. Also, the quote is a good question that I can not now answer.

      Part of the answer may be that lenders must possess before they can lend. Similarly, taxes can only be collected from those who possess.

      Based on possession, borrowing increases wealth but taxation redistributes wealth.

  4. "What would the operational channel be that caused more spending between taxing and T-bonds even though the net effect on bank deposits is zero?"

    If the taxes equal government spending then no net financial assets are added. If thereb are T-bonds added then those are net financial assets. Banks can borrow against government securities. Money supply is endogenous. You add net financial assets and It makes no difference in MMT view wheter It's money or T-bonds. Interest rate might make a difference but for simplicity you can imagine that interest was paid on reserves equal amount with T-bonds.


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