I was just reading this Krugman article which contains the words...

I’ve already mentioned that having at least some government debt outstanding helps the economy function better. How so? The answer, according to MIT’s Ricardo Caballero and others, is that the debt of stable, reliable governments provides “safe assets” that help investors manage risks, make transactions easier and avoid a destructive scramble for cash.

Now the "help investors manage risks" part I can understand, but "make transactions easier" and "avoid a destructive scramble for cash" are a mystery to me.


3 Answers 3


This is because there is strand of literature that suggests government debt has positive impact on market liquidity (eg see Grobety 2018). When Krugman talks about scramble for cash he likely refers to lack of liquidity which is clearly bad for business. Also more liquidity makes transactions easier because it’s easier to find buyer for your asset.

However, I think Krugman is a bit prone to over-dramatization, and while there is some good empirical work supporting the result, it is not completely beyond critique.

  • $\begingroup$ Sorry but I am still confused. When you say "lack of liquidity which is clearly bad for business" do you actually mean falling liquidity is bad for business? Also when you use the word "liquidity" do you actually mean just "money"? $\endgroup$
    – Mick
    Aug 14, 2021 at 12:25
  • 1
    $\begingroup$ @Mick no low level of liquidity is bad for business. Liquidity is ability to turn assets into cash. For example, if you have a bond but there is no market where to resell it then that bond is highly illiquid that is bad for a business since in emergency you might want to exchange bonds you hold for cash. No liquidity is not just money liquidity is again ability/speed at which asset can be turned into cash. Cash is perfectly liquid check little bit less liquid car or house quite illiquid. $\endgroup$
    – 1muflon1
    Aug 14, 2021 at 12:39
  • $\begingroup$ Would it also work if the government didn't have outstanding debt, but was ready to provide debt on demand? Let's say, if there is demand for debt they will start building a new railway financed with debt, but otherwise they won't. $\endgroup$
    – user253751
    Aug 16, 2021 at 17:56
  • $\begingroup$ @user253751 no the mechanism of action is that by having a lot of debt government creates big bond market and if the bond market is not big there usually are fewer secondary buyers and sellers. But this has nothing to do with the government debt per se other than it creates large market for bonds. Just issuing occasionally debt would likely not support big bond market, what helps to make the market so liquid is a lot of government debt of various maturity $\endgroup$
    – 1muflon1
    Aug 16, 2021 at 18:08

Bonds function as extremely low-risk assets.

They can therefore function as investments with a positive rate of return while cash has 0 rate of return. This means in general, banks would prefer to hold bonds to cash whenever possible.

Banks then allocate some nontrivial portion of their assets to bonds instead of holding cash, allowing them to lend more out. This increases the velocity of money/money multiplier.

  • $\begingroup$ The velocity of money can only be increased temporarily and the money multiplier does not exist so this can not be the explanation. $\endgroup$
    – Mick
    Aug 14, 2021 at 18:18
  • $\begingroup$ @Mick why do you say money multiplier does not exist? Just by accounting definition there is always some money multiplier in the economy which is the ration of broad money to narrow money. Money multiplier is also not the same as money multiplier model $\endgroup$
    – 1muflon1
    Aug 16, 2021 at 19:44
  • $\begingroup$ Because he said "allowing them to lend out more" I presumed he meant "money multiplier" in that way that textbooks teach (incorrectly) that total bank lending is limited by the "money multiplier". If it was meant in some other way then my bad. $\endgroup$
    – Mick
    Aug 16, 2021 at 22:32

The global financial crisis is also called a modern bank run which is what Krugman probably has in mind as transaction problems and the destructive scramble for cash.

Economist Hyman Minsky says every unit in the economy has a position in assets that are not liquid. To gain and keep legal control over this position the unit makes use of position-making instruments.

Hyman Minsky's Financial Instability Hypothesis and the Accounting Structure of the Economy:


Minsky defines his accounting representation of a “capitalist” economy under investigation. Accordingly, a capitalist economy structure comprises capital assets (employed to the pursuit of private incomes and wealth) and a financial system “that makes the indirect ownership of wealth possible” (1986, p. 78). In particular, financial instruments (be them short-term note, bond, deposit, insurance policy or share of stock) are used to “finance control over capital assets,” and involve a commitment to pay cash at some time or triggering event, generating indeed a “complex system of money in/money out transactions” (1986). Use of financial instruments implies that cash is needed to fulfill these commitments. According to Minsky, cash can be obtained: from funds in hand; payments from wages and profits; moneys generated by owned financial contracts; sales of physical and financial assets; borrowing; and creation of cash, the latter being the privilege of government, banks but also money market funds and various broker cash-management accounts (1986, pp. 78–79 and footnote 2).

Liabilities, the other side of a firm’s balance sheet, are commitments to make payments; the payments are dedicated to both repaying and servicing debt. Cash to meet these payment commitments can be obtained either from the gross profit cash flow, cash on hand, the sale of assets, or borrowing.

The balance sheet of a bank or nonbank financial intermediary can be described in general terms as follows:

Assets: cash + marketable securities + portfolio of financial assets

Liabilities & Equity: insured debt + uninsured debt + equity

Government debt is usually the highest quality or safest credit in the pools of marketable securities that banks and nonbanks hold in their liquidity cushion as position-making instruments. Therefore more safe assets improve liquidity and ease transactions especially as the remedy for a destructive scramble for cash.

When investors make a systemic run away from holding the uninsured debt of the banks and financial intermediaries then cash becomes scarce because it is generated by transactions via financial intermediaries which tend to grow the systemic balance sheet. In other words the liabilities and equity are position-making instruments for banks and nonbank financial firms in the lexicon of Hyman Minsky.

During a run away from unsecured investments Minsky says units are forced to "sell position to make position". This means the sale of portfolio assets to keep cash flow obligations to hold the remaining portfolio. When many units are selling position to make position it is called a "fire sale" and this unwinds the balance sheets of the financial sector via forced deleveraging by panicked investors holding their uninsured liabilities and equity. Equity will take the first loss on a fire sale of assets from portfolios so equity and uninsured debt placement both become scarce. When the aggregate financial sector is forced to deleverage or shrink balance sheets this disrupts the market transactions that make cash seem abundant rather than scarce.

Minsky says may units may be forced to "sell position to make position." This means those units cannot roll-over and grow liabilities due to lack of willing counter-parties and are forced to sell marketable securities and then sell portfolio holding out of their "position". So the global financial crisis has been called a Minsky moment because he describes the mechanism active in the destructive scramble for cash during a systemic crisis.

When a bank expands its asset portfolio this increases the money supply held as financial assets by the nonbank sector. When a bank or bank sector is forced to sell portfolio assets to the non-bank sector this reduces the money supply because banks create money (deposits) via balance sheet expansion and cancel money (deposits) when forced to sell financial assets to nonbanks. So a modern bank run can be seen not only as a destructive scramble for cash but ironically as a scramble for cash that destroys cash (deposits) via forced deleveraging of the bank sector.


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