I have always thought that the US Treasury issues bonds to raise money to allow the US to pay off debts in the short- and long-term. However, recently, I have read in a book on Modern Monetary Theory that that is not the purpose of bond issuance by the Treasury. In fact, the Treasury issuance of bonds serves the purpose of aiding the Fed in conducting monetary policy. May I know if this is the case? If that is the real purpose, then what then does the Treasury do to raise money to pay off US debt?

  • $\begingroup$ " US Treasury issues bonds to raise money to allow the US to pay off debts in the short- and long-term. However, recently, I have read that that is not the purpose of bond issuance by the Treasury." Where did you learn that? Can you please provide source for such statement $\endgroup$ – 1muflon1 Jun 17 at 10:59
  • $\begingroup$ @1muflon1 I have added in the reference $\endgroup$ – Tan Yong Boon Jun 17 at 11:11

There are some semantic issues here. A more careful statement of the MMT position is that there is no economic reason for the Treasury to issue bonds. However, there is a self-imposed institutional need to do so: the Treasury has a balance at the Federal Reserve, and the rules it follows appears to imply that the balance cannot go negative. Issuing a Treasury increases that balance, as that is where the borrowed money goes. Note that I believe that some MMT academics have argued that there is no legal need for the balance to remain non-negative - and thus this argument does not apply - but I do not have the legal expertise to judge those arguments. In any event, the Treasury acts as if this requirement exists.

However, the economic purpose of the bonds is that they offer an alternative to holding deposits at the Fed (“reserves”), and bear interest. They create a risk-free yield curve that acts as a benchmark for private sector borrowing. The Fed can set the overnight rate, and influence the rest of the yield curve. This allows it to conduct interest rate policy.

Note that although the phrasing might be disputed, the previous paragraph describes very well all standard models that include a bond market. As such, there’s no debate about the facts, rather the interpretation of the facts.

If that is the real purpose, then what then does the Treasury do to raise money to pay off US debt?

When a Treasury bill/bond expires, it is paid out of the Treasury’s balance at the Fed. This balance comes from tax receipts, and bond/bill issuance. Like corporate borrowers, the stock of Treasury bonds is continuously rolled over.

This mechanism has very little to do with the Fed’s conduct of monetary policy, it’s just the mechanics of bond issuance.

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  • $\begingroup$ Are the tax payments that the Treasury insufficient for it to maintain a non-negative balance at the Fed such that it needs to issue bonds to raise more money? $\endgroup$ – Tan Yong Boon Jun 17 at 11:44
  • $\begingroup$ There are seasonal variations, where taxes are greater than spending, but over the year, the average is typically a deficit. This means that a balance will get run down. $\endgroup$ – Brian Romanchuk Jun 17 at 14:05
  • $\begingroup$ According to articles, such as this (forbes.com/sites/johntharvey/2012/09/10/impossible-to-default/…), the US govt has the autonomy to print money if it needs to service debt. If that is the case, why issue bonds in the first place? Why not just print money to finance the government's day-to-day activities? $\endgroup$ – Tan Yong Boon Jun 25 at 11:31
  • $\begingroup$ Or is it because there is some constitutional obligation for the US govt to only be able to print money to service its own debt and not to print money directly to finance its day-to-day operations for greater accountability? $\endgroup$ – Tan Yong Boon Jun 25 at 11:37
  • $\begingroup$ “Constitutional” is not the word; the regulations/laws covering this were passed by Congress, and can be changed by Congress without a constitutional amendment. The usual understanding of the laws suggests that the Treasury needs to run a positive balance in its accounts at the Fed, but other laws (and part of a constitutional amendment) suggests that default is illegal. There’s never been a legal test of which of these contradictory laws has priority. In order to keep a positive balance at the Fed, the Treasury needs to eventually issue debt if it runs deficits. $\endgroup$ – Brian Romanchuk Jun 25 at 13:29

I agree with @BrianRomanchuk +1 answer which is written in the context of modern monetary theory (MMT), but an important thing to note here is that MMT is not widely accepted monetary theory in economics and in fact it has been criticized a lot by mainstream economists (See for example this paper, Krugman's blog, Cochrane's blog and so on). Since your question is more broad as you are asking if this is indeed the case let me expand on by providing mainstream thinking on government debt.

In mainstream economic thought bonds are not issued just in order to allow Fed to conduct monetary policy but for various reasons. Chief among them is that not all government debt is purchased by new created money through Fed so issuing debt is not just done to allow Fed to conduct it's monetary policy. In fact debt is a way how government can in principle raise additional funds without increasing inflation if the debt is not purchased by Fed using newly created money. This is useful to fund public projects which offer high enough returns, and it is also useful because from public economic perspective it is not optimal to always shift tax rates whenever government temporary needs more funds.

As correctly explained in Brians answer MMT argues that there is no point in Treasury to issue debt as they view it as just institutional 'theater'. This is because MMT rejects the idea that funding excessive government spending with debt will be inflationary. Consequently many MMT proponents are also arguing for expansionary fiscal policy that should always keep economy at full employment and that it should be funded through monetary expansion. If you adopt such view then you might as well argue that instead of issuing debt and buying it Fed should just 'print' (or in this day and age electronically transfer) newly created money to the treasury. This is not generally accepted idea in the profession outside of situations such as zero lower bound which are covered by standard mainstream theory.

Hence the proposition that the real purpose of issuing bonds is just to let Fed conduct monetary policy or that it is just an institutional charade is quite contentious one. In fact a more mainstream view would include raising excess resources to cover debts of the government in addition to viewing it as just vehicle for monetary policy.

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  • $\begingroup$ Hmmm... Well... The book I am reading says MMT was once-criticised by the majority but now, has become widely-accepted as correct. I am quite puzzled by some of its central tenets as well and also by its suggestion that governments can deficit spend as they wish as they need not maintain a balanced budget $\endgroup$ – Tan Yong Boon Jun 18 at 1:57
  • $\begingroup$ Then what does MMT have to say for excessive debt and the chances of a government going bankrupt? In MMT, how does a government be financially accountable to its people? $\endgroup$ – Tan Yong Boon Jun 18 at 2:00
  • $\begingroup$ @TanYongBoon MMT is definitely not widely accepted in economic profession -at least definitely not in academia. If you make google scholar search on the topic you will find only few papers and the more cited ones are mostly critical as the above sources show also economists who like Krugman or Cochrane who would disagree on a lot policy wise both are critical to it. In fact one problem with MMT is that it can’t even be properly analyzed because it’s proponents are not formalizing it. $\endgroup$ – 1muflon1 Jun 18 at 8:32
  • $\begingroup$ @TanYongBoon MMT argues that it does not matter what the deficit is because sovereign issuing debt in its own currency can in principle never bankrupt as it can monetize its debt and in addition its argued that it won’t lead to inflation so there is not much downside to doing it. The mainstream economics would not disagree on the first assertion but would with the second. It is accepted by the profession that monetary expansion in liquidity trap won’t lead to inflation but that’s not natural state in which economies exist. I also have problems understanding MMT because it’s not yet properly $\endgroup$ – 1muflon1 Jun 18 at 8:37
  • $\begingroup$ formalized and it’s hard to judge and understand theory if you can’t examine its formal representation. When theory is just laid down in words it’s hard to notice logical inconsistencies. I am personally trying to keep open mind about MMT but I must say that so far it made mostly buzz in blogosphere and mostly among non-economists than within the profession. If it would turn out to be correct or more correct than current monetary theories then it would be exciting new development within the profession, but so far most academic work on it is critical $\endgroup$ – 1muflon1 Jun 18 at 8:57

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