As the accepted answer points out, the premise of my question was flawed. Thank you for the dispelling of my wrong assumptions. The original question follows.

There are two related questions (and feel free to assume the Central Bank in the questions is USA's Fed):

  1. When the Central Bank sells bonds, where does the money go ultimately?
  2. How separate is the Central Bank budget from the government's budget?

To clarify: If the Central Bank sells \$1000M worth of bonds in order to repay \$800M old maturing debt and to raise an extra \$200M, does this \$200M simply become available for use to the government? Or is there some extra process in order to transfer money between the government and the central bank? Who decides (central bank, executive branch, legislative branch) how much new debt the central bank will be selling?


3 Answers 3


Firstly, the central bank doesn't issue bonds. The treasury (in the executive government) does, as a way to finance government expenditure, and make real investments in the economy.

In modern economies, the central bank's primary focus is the interest rate at which they lend money to private banks. If they require more money in order to finance those loans, they will simply create more money, as they have the legitimacy to do that. (Note that most money that is created is not physically printed, but rather it is just the electronic entry of that currency, in the initial transaction. An economy requires a fraction of electronic money to exist as cash, so a fraction of created money is printed.) However, fiat money requires some security to give it legitimacy. To this end, the central bank holds securities, stocks, precious metals, cash and foreign currency in its reserves. You can see here that bonds form part of those reserves, so that is why central banks buy treasury bonds. Plenty of other domestic and foreign financial institutions also buy treasury bonds, as part of their reserves to give legitimacy to their "demand deposits" (which is fiat money), or as part of a strategy to lower the risk of their investment portfolios. Private banks also create money by loaning out their demand deposits.

Analogously, if the central bank raises the interest rate (in order to curb inflation), they will be slowing down the growth of money (which can be thought of as a "leakage"), and that is a situation in which they would buy fewer bonds.

Central banks need to operate autonomously from the executive government, and this autonomy is usually enshrined in the respective country's constitution. When this doesn't happen, the executive government could force the central bank to buy their bonds, which creates a huge injection of money into the economy. This money that is created belongs to the government, so they spend it in order to achieve policy goals, however, after a while the currency becomes worth less and less (as inflation is high). That is the main cause of high inflation. When the central bank is autonomous, they have control over the monetary system, and keep inflation in check with the central bank interest rate.

  • $\begingroup$ A relevant quote: "After the 2007-08 financial crisis, central banks embarked on a radical project to keep credit cheap, called quantitative easing, or QE. This is often referred to as printing money, though it doesn’t actually involve any new tender being printed. Instead central banks created more electronic money in their ledgers and used it to buy government bonds and other securities." ( economist.com/1843/2021/10/18/… ) $\endgroup$
    – ahorn
    Commented Dec 21, 2021 at 16:47

Federal reserve, has no limit on how much money they can print. Thus, when central banks buy bonds , new money flows into the system.

Also, when federal reserve sells the bond , the money is taken out of the system.

  • $\begingroup$ I might be severely misunderstanding something in this case. If "the fed selling(issuing) bonds" means money is taken out of the system, how can the government/fed sell bonds in order to raise money for large projects? $\endgroup$
    – Krastanov
    Commented Aug 17, 2019 at 0:59
  • 2
    $\begingroup$ It is the treasury that sells bonds to the institution (Goldman, Morgan Stanley) etc., to finance the large projects. In other words, budget deficit is financed by treasury and not by central banks. $\endgroup$
    – nsivakr
    Commented Aug 17, 2019 at 10:32

This question is a few years old now but I felt the other answers weren't quite hitting the mark so I thought I'd add some fundamentals. It's necessary to understand "where the money goes ultimately".

Note that the below is from a heterodox economics perspective incorporating aspects of modern monetary theory backed up by empirical research and understanding of banking operations

When the US government decides on its policy objectives, it establishes an annual budget via Congress. This budget represents the amount of money required to achieve its objectives over the following year. A large amount of this will be for non-discretionary payments (eg. social security, welfare, medicare, etc), another big chunk will be to hire the labour of people to carry out the gov's priorities, and some more will be to buy raw materials, products, or services from people or organisations that the government will need.

The next step is that the US Treasury will instruct the Federal Reserve to make payments. This involves the fed increasing the value of USD reserves held in the fed account of the bank of the individual or organisation selling the labour, good or service. The Treasury's account at the fed is debited the same amount. That commercial bank will then make a corresponding increase in the deposits held by the individual or organisation at that commercial bank. See Fiscal Data from the US Treasury for an overview of this spending process and the breakdown. The key is The President and Congress pass laws which mandate spending to occur. Also, see Tymoigne 2023; pg 17:

The central bank routinely helps finance the Treasury... it just ensures that the Treasury has enough funds to implement the budget passed by Congress.

The end result of this transaction is that the seller's net financial assets have increased (more money in their bank account with no increase in liabilities), the commercial bank's liabilities have increased (i.e. they now owe the seller more money should they wish to make a withdrawal), and their financial assets have also increased, with a higher amount of USD reserves held in their Federal Reserve account. So the bank's net position has remained unchanged.

The above is how all government expenditure occurs on a mechanical level.

However, if nothing else changes, this expenditure can eventually result in too much demand for the supplied goods and services in the economy and the price level will increase to compensate. Inflation occurs.

To address this, the US Government proceeds to use its legal authority to apply tax liabilities on people and organisations. By reducing the amount of USD available, the Government is decreasing the financial ability of actors in the economy to spend, thereby reducing the demand for goods and services in aggregate. This acts to counter the increased demand pressure caused by the preceding Government expenditure. The aim is price stability, or more accurately, a low and stable, but positive, non-zero inflation rate. See Baker et al. 2020 and Tymoigne et al. 2013 for more on the role of tax. Also see Tymoigne 2023; pg 17

...national government that issues the domestic currency, and taxes and issues securities to destroy the currency

However, historically each year (apart from a few exceptions), the government fiscal balance has been in deficit. This is a non-government surplus. The surplus refers to the fact that the money supply available to the non-government sector has net increased as a result of spending more than is taxed away.

This is often a good thing because, as economies grow, they need more money to facilitate the increased number of transactions and stocks and flows of goods and services. This is evidenced by the fact that the US non-government sector has experienced a surplus almost every year of its existence (see FRED US government deficit data) and yet standards of living and the productive capacity and capability of the US economy and society is far higher than it was in the past.

Now, so far, I've mentioned nothing about bonds. This was on purpose as ultimately, Government bonds are a less vital part of the monetary story.

By historical convention (and two further primary reasons given below), the US government decides to sell US Treasury bonds to cover any deficits it runs. The Treasury creates the bonds and issues them via auction to commercial banks with reserve accounts at the Fed (see How Auctions Work for an explainer). The purpose of issuing these bonds is to provide a risk-free saving vehicle and to help the central bank achieve its interest rate target. Remember, the reserves (commercial bank assets / central bank liabilities) used by the commercial banks to purchase these Treasury bonds were placed there when the Government spent on its priorities and instructed the central bank (monoply issuer of USD reserves) to create them. See The Fed Explained, specifically page 86:

The Reserve Banks also act as fiscal agents of the U.S. government and certain other entities. In other words, they act as the “government’s bank” and maintain the operating cash account of the U.S. Department of the Treasury; process payments to and from the Treasury’s Federal Reserve account; and issue, transfer, and redeem U.S. government securities.

See also Tymoigne 2014; pg 9 following a detailed analysis of federal reserve and US Treasury operations:

Treasury has issued securities for other purposes than funding itself. One reason is to provide a means of payment for the country; another is to help the Federal Reserve in its interest-rate stabilization operations; a third one is to help financial institutions meet their capital requirements and to provide a foundation upon which all other securities are valued by providing a proxy for the risk-free rate

So quite literally, bond issuance is a process of 'mopping' up excess reserves in the system that the government put there.

So, in a directly analogous way to how tax revenues are destroyed/deleted, the reserve dollars used to buy government bonds are simply destroyed. The money doesn't go anywhere.

Current budgetary procedures do require, by regulatory convention, the Treasury to issue Treasury bonds to cover any deficits, but this is an artificial and political requirement, not a fundamental economic requirement.

How separate is the Central Bank budget from the government's budget?

As a shorter exposition on your second question, it is important to recognise that, while the US Treasury and Federal Reserve are operationally independent, they liaise closely with one another daily to coordinate fiscal and monetary operations (since the federal reserve is factually the government's bank and fiscal agent).

It is misleading to say the federal reserve has "a budget". It holds assets (eg. Treasuries it bought with newly created reserves via Open Market Operations (OMO) see The Fed Explained again) and liabilities (primarily electronic reserves held by commercial banks).

  • 2
    $\begingroup$ Taxes do not necessarily reduce inflation, there are whole papers that show empirically sales taxes contribute to inflation $\endgroup$
    – csilvia
    Commented Oct 17, 2023 at 10:52
  • $\begingroup$ True, the fastest way to cut inflation in the short term is slash sales taxes on consumer goods and services. I was more referring to taxation in general - which does indeed act to prevent inflation. $\endgroup$ Commented Oct 17, 2023 at 11:05

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