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To properly clarify the motivation of the doubt think of a hypothetical world when there are no business cycles and Central bank intervenes in the market only to provide enough liquidity to sustain the nominal growth.

Due to inflation currency required in the economy keeps going up. To inject more currency in the economy CB engages in OMO. Now based on the construct here, there are no cycles that economy will overheat and at that time central bank will sell these securities from its books to suck currency out.

In such a scenario the Central bank will keep accumulating securities on its books. What happens when these securities mature?

Govt paying the principal to CB is equivalent to monetizing the govt expenditure. Does this mean a part of govt debt will always be monetized?

I understand this is a hypothetical construct but it is only to separate the money creation process for stabilization vs usual growth purposes. Some money will always need to be created over and above the requirement of stabilization policy. I am interested in understanding the impact of that.

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Multiple things could happen. Two main cases that come to mind are:

  1. Government will repay them and if central bank wants to keep things as they were they can purchase newly issued bonds or conduct some other expansionary monetary policy.

  2. central bank could decide to retire those bonds meaning government does not need to repay them.

Govt paying the principal to CB is equivalent to monetizing the govt expenditure. Does this mean a part of govt debt will always be monetized?

This is not correct. Repaying the debt reverses the previous monetization.

Monetization of government debt, and by extension also the resulting expenditure, occurs when central bank buys government debt. As the investopedia mentions:

The central bank … by purchasing government bonds in private markets can keep interest rates low, and in a sense, monetize government debt.

So the debt or extra expenditure from that is already monetized once central banks buys that debt.

Repaying the bonds effectively reverses the previous monetization. To repay the debt government has to collect taxes and thus siphon money from the economy.

Scrapping the debt would effectively mean the debt is permanently monetized.

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  • $\begingroup$ "Repaying the debt reverses the previous monetization". I didn't quite understand this. The way I see public was just an intermediary. When bonds were floated, public paid money to govt. When CB bought these bonds money went to public again. Now govt pays back the money taken by public to itself (CB). Effectively it got the money from CB (by newly printed money)? Where's the flaw in this thinking? $\endgroup$
    – Dayne
    Commented Mar 1, 2022 at 7:50
  • $\begingroup$ @Dayne this is how the chain goes 1. Government floats bonds let’s say 1000e. 2 public buys that 1000e with existing money (no monetization occurs no new money were created). 3. Central bank buys the bond with 1000 new created euros (this would be the monetization of government debt because this effectively means there is 1000 more euro that financed the debt (public was just intermediary).. Now we get into fork. 4A government repays the debt- this requires government to siphon 1000e from the economy and give it to CB effectively canceling past monetary expansion $\endgroup$
    – 1muflon1 ♦
    Commented Mar 1, 2022 at 8:12
  • $\begingroup$ 4B central bank decides to never collect that extra 1000e is not permanently part of money supply. The previously mentioned step 4A represents cancelation of monetization effectively $\endgroup$
    – 1muflon1 ♦
    Commented Mar 1, 2022 at 8:13
  • $\begingroup$ @Dayne but CB destroys that money once it gets them. From accounting perspective CB has a liability when it creates money. This liability is created against government bonds which for CB are assets. Pay back the bonds and CB destroys the liability. This is not part of the CB profit that goes to government (that’s the extra interest that’s not destroyed and just forwarded to the gov) $\endgroup$
    – 1muflon1 ♦
    Commented Mar 1, 2022 at 8:18
  • $\begingroup$ Ok. So now if all the money that was injected into the economy via OMO gets destroyed how does at the time of repaying it how to sustain growth of cash? By continuously buying more and more bonds right? What if govt stops borrowing at the required rate? $\endgroup$
    – Dayne
    Commented Mar 1, 2022 at 8:22

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