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From my understanding of the current monetary system when a bank issues a loan it is effectively creating money for the receiver of the loan i.e Mortgage. This increases the M1, M2, M3 numbers of the monetary aggregate.

In the news in the past year or so the US government is attempting to pay for a lot of new spending by issuing a lot of bonds. Stimulus + Infrastructure.

Those bonds need to be sold and I am assuming initially it is a set of primary dealers that are the market makers for the bonds. I am guessing most if not all the primary dealers are banks with the ability to create money.

So when the government issues new bonds does that mean the primary dealers actually issue new money to purchase those bonds that will increase the M1, M2, M3 aggregates?

Also when the Fed performs QE it is effectively swapping those bonds for reserves.

So when the US government issues another 2T of bonds it is effectively increasing the money supply by 2T.

Is my model of understanding correct?

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A brief answer: you have it a bit wrong. Thinking about Primary Dealers this way is misleading. Although PDs do buy some bonds at auction, their function is mostly to facilitate sales to the public. So think of government bond sales as sales to the public. Then you can see that government selling bonds to the public is actually a monetary contraction (money moving from public to government). This is the opposite of QE which is a monetary expansion. However this is a complex subject as noted by @mick

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  • $\begingroup$ "government selling bonds to the public is actually a monetary contraction" - not true. I think you are confusing this with a central bank selling bonds - which does indeed shrink the money supply. $\endgroup$
    – Mick
    Nov 20, 2021 at 15:12
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    $\begingroup$ I disagree - Treasury and Fed are both the government. $\endgroup$
    – dm63
    Nov 20, 2021 at 17:00
  • $\begingroup$ When the government sell their freshly made bonds to the public, pre-existing money is transferred from the public to the government. No money is created or destroyed in the process. If you think it is then please explain how exactly. $\endgroup$
    – Mick
    Jun 17 at 7:15
  • $\begingroup$ If Treasury sells bond to the public, the money goes to the Fed in an account called the Treasury General Account. This money comes out of public bank accounts, thereby reducing banks’ reserve accounts at the Fed. I consider that a monetary contraction. If and when the Treasury spends down the TGA again, that would be an expansion. The combined act of selling bonds and spending the proceeds is reserve neutral. $\endgroup$
    – dm63
    Jun 17 at 10:34
  • $\begingroup$ Now we are in agreement. $\endgroup$
    – Mick
    Jun 17 at 15:33

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