Why is national debt bad if the central bank can keep buying bonds?

Question

When I read about national debt, it's usually about how debt is bad because with too much debt, debtors would demand higher interest rates. Eventually the government can't pay the interest, defaults, and the economy collapses.

However not discussed is why the central bank can't just step in and keep lending money to the government. It's not like the central back doesn't already do that - according to this article, 27.6% of the US national debt is currently to another arm of the government. But if the central bank can just keep buying government bonds, the government can also force the interest rate on its debt as low as it desires (just get the central bank to buy more bonds), not to mention deficit spend to its heart's content. And if the government is able to do that, then national debt isn't a problem at all!

It seems to me that there's only a problem if 1) the country doesn't have a central bank or 2) you're using another country's currency (e.g. for members of the Eurozone). Am I missing something?

Answer 1

Yes.

The central bank (say the Fed in U.S.) can purchase bonds, but notice:

1. The Fed is not going purchase t-bonds and t-bills directly from the Treasury. It will only purchase or sell bonds in the market. ("Open market purchase" or "open market sell.")

2. Open market purchase is not only the buying of bonds, but also the creation of money. (You sell bonds to the Fed, and the Fed will pay you.) Increase in money supply means inflation. Obviously, the Fed can't buy too much bonds, or the U.S. will have to deal with disastrous hyperinflation.

3. Most central banks have some degree of independence in determining what to do. The Fed won't purchase more than they want, and the government is not able to force them.

Answer 2

This site is aimed to give non-opinion based answers; this question is worded in a way that leads to opinions (“bad”). I will do my best to give a straight answer.

I would argue that it is safe to say that there is a lot of hidden politics in discussion of fiscal policy and government debt. If someone does not like policy X, and policy X is popular, it is politically easier to attack X’s effect on government debt than X itself. This could explain the tone of discussions you have read.

As you note, it would be possible for a government to set the interest rates on all of its debt if it borrows in a currency that it controls (via control of the central bank). The standard argument against such a policy is that by doing so, the central bank would lose control of inflation. (That is, it needs to be seen to have the flexibility to raise interest rates to keep expected inflation under control.) There’s a lot of different theoretical arguments to get to that result. (As a disclaimer, I would note that I disagree with them, so I will not attempt to present them.)

Unfortunately, these arguments are often based on cryptic mathematics. You could try asking another question specifically on that topic to get a further background. (I did a quick search, but the questions I saw had various issues. In order to get good answers, you need to ask a very specific question, and avoid introducing editorial comments, as answers end up responding to the editorial comments.)

The next line of attack is that by increasing debt, interest costs are rising (assuming interest rates are positive). This implies that these costs become an increasingly large part of the budget. Furthermore, overlapping generations models (OLG models), typically suggest that this results in generational unfairness. (Future generations are disadvantaged relative to the current generation.)

Finally, there is the “intertemporal governmental budget constraint.” This constraint - if it holds, which is unclear - suggests that governments will need future primary surpluses to match current debt levels. (The primary surplus is the budget balance excluding interest payments.) The theoretical status of the budget constraint is controversial, but one could argue that it is related in practice to the previous argument about interest payments.

Answer 3

For the central bank to keep buying government debt indefinitely, it would have to start printing money at some point. That has the usual drawbacks from printing money, such as (hyper-)inflation.

Answer 4

Because it make inflation expectations (and thus actual inflation) high, and does this in two ways: first of all because the newly created monetary base used to purchase government bonds is used by the government to purchase goods and services (a thing that drives up the aggregate demand and so increases the general price level, the thing we call "inflation") and so put upward inflationary pressures that drive inflation expectations for future periods since the lack of credibility in respecting the price-level mandate, which in turn will result in more inflation in the future. Second, by persistently keep on buying bonds the central bank pulls the interest rate below its "natural" level in a manner that will be enabled a sort of wicksellian "cumulative process" that eventually will result in very high inflation rates.

So, to sum up: a central bank has the role to ensure price stability either by controlling the money supply(by pursuing an announced growth rate of the money supply) or interest rate (by setting the real rate equal to the "natural" rate of interest, which implies an economy at its full potential with low inflation). But it's not central bank duty to ensure fiscal policy goals, since this can result in very negative (inflationary) scenarios for the economy.

Answer 5

There are two points here we need to consider

1. Government needs to give collateral (Government securities) in order to get loan from central bank, central bank can't buy g-sec by printing currency as it wants, there will be some limit based on the economic conditions of that particular country, if it prints money without limit it will lead to INFLATION.

2. Banks and Financial institutions can buy securities through open market operations, if they keep on buying g-sec, it will lead to CROWDING OUT, that means banks will not have enough amount to lend, this will lead to decrease in investments.