4
$\begingroup$

I'm aware that the fed controls the supply of money by contracting and expanding through permanent and temporary open market operations. Consisting of purchasing Treasury securities or through repos. These are sold primarily to primary dealers I derstand but also to other organizations.

Can someone explain how the interest that is paid is set during auctions? Additionally it seems that the securities alone can not introduce money but through the interest paid on them?

|improve this question
$\endgroup$
  • 3
    $\begingroup$ Is it possible to change the title of this question? You are asking how yields are set in auction, not how money is introduced. $\endgroup$ – Brian Romanchuk Jan 27 '18 at 13:56
  • $\begingroup$ Well I'm insinuating that money is only actually introduced to the long term net supply by the "yield". Because when it adds money by purchasing bonds those bonds had to have been bought at face value meaning at one point the gov took out that money. The only new money is what is introduced by the interest or premium paid on the security. How that interest is determined is arguably also how new money is introduced? $\endgroup$ – marshal craft Jan 27 '18 at 15:04
  • 1
    $\begingroup$ No. A government deficit sends money to the private sector, which allows it to buy the bonds. It is a circular flow. This is how Japan can increase debt/money stock with near-zero interest rates. If you do a web search for my name and “simplified model of government finance”, I have a longer tutorial on the topic. $\endgroup$ – Brian Romanchuk Jan 28 '18 at 15:41
  • $\begingroup$ I will require further explaining than that, will give it a look. I didn't think gov employees and what not might be paid externally from public institution or bank ultimately linked to bond owners. I am aware there are inter gov bonds and Treasuries. $\endgroup$ – marshal craft Jan 29 '18 at 7:33
7
$\begingroup$

The Treasury auction process is described here: Treasury Direct

Bidders can either enter competitive or non-competitive bids. Non-competitive bids are limited in size; the price is set by the competitive bids, which generally come from Primary Dealers (that are obliged to bid).

As a simplified example of the bidding process, assume that the government announces an auction for $2 million in 30-year bonds. (Note that this example ignores bidding size limits.)

There are three bids:

  • a bid for \$1 million at 4% from A
  • a bid for \$1 million at 4.25% from B
  • a bid for \$1 million at 4.50% from C.

The government looks at the bids (starting with the lowest yields) until the amounts cover the amount to be issued. The highest winning bid yield is used for all. In this case, that means that A and B get filled with a $1 million in bonds at 4.25%, and C gets nothing.

The connection to money is somewhat complicated. The issuance of the bonds reduces the money supply - the bidders have to pay for the bond. The coupon and principal payments will increase the money supply.

|improve this answer
$\endgroup$

Your Answer

By clicking “Post Your Answer”, you agree to our terms of service, privacy policy and cookie policy

Not the answer you're looking for? Browse other questions tagged or ask your own question.