When the central bank wants to reduce the money supply, it can sell bonds. That way, the money supply reduces by the amount paid for the bonds. The buyer will have bonds instead of cash. The bonds can be used as a currency (e.g. exchanging the bonds for goods and services, or using the bonds as collateral for borrowing money). If the bonds are indeed used as currency, wouldn't the bond sale by the central bank have failed in its objective to reduce money supply?
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2$\begingroup$ This also applies to increasing money supply, which means in your view, central banks cannot change money supply at all. $\endgroup$– AlexNov 11, 2022 at 20:46
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$\begingroup$ @Alex it would not apply if the central bank simply printed or unprinted dollars $\endgroup$– user253751Nov 15, 2022 at 5:55
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$\begingroup$ Does this answer your question? Is it reasonable to consider government bonds as money $\endgroup$– MickDec 14, 2022 at 16:43
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2 Answers
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First, bonds do not count as money because they typically have too long maturity so they will not qualify even as broad money (M3). However, if they would qualify as a money then it would still reduce money supply.
If you count the bond as money then when the 1000 dollar bond was issued by government and bought by newly created central bank reserves then 2000 dollars will be created (bond with nominal value of 1000 and reserves worth 1000). When central bank sells the bond, it gets back the 1000 so money supply would drop by 1000.
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$\begingroup$ Can anything count as money if it's used as a medium of exchange? for example Bitcoin has infinite maturity (it never converts to dollars) yet it still contributes to the money supply, right? $\endgroup$ Nov 11, 2022 at 19:07
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1$\begingroup$ 1. For something to be money medium of exchange is not enough, it also has to be unit of account and store of value. 2. Every currency has its own money supply. Bitcoin adds exactly 0 to the money supply of US dollars, it only adds to money supply of bitcoins $\endgroup$– 1muflon1 ♦Nov 11, 2022 at 21:09
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$\begingroup$ suppose US government issues Dollars2 instead of Dollars. They are pegged at 1:1 ratio but the government hasn't yet needed to print any Dollars to cover the peg (as everyone just accepts Dollars and Dollars2 are equivalent, banks settle in whichever they have most available, etc). would this not expand the money supply? $\endgroup$ Nov 11, 2022 at 21:20
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2$\begingroup$ Not of US dollars. I mean what sort of a question is this? Imagine that company x produces ice cream and shampoo. Both shampoo and ice cream happen to have same price, so if they produce more shampoo did ice cream supply increased? Of course not. Dollar 1 and 2 despite of peg are two separate currencies $\endgroup$– 1muflon1 ♦Nov 11, 2022 at 21:22
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1$\begingroup$ @user253751, what exactly are you trying to achieve? It should be very obvious that buying and selling bonds by a central bank alternates money supply. $\endgroup$– AKdemyNov 11, 2022 at 21:30
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When bonds are sold by the central bank then existing bonds will have their value drop. For example, if you got a bond for 10% coupon at 10K and the central bank sold bonds now in the secondary market they are priced at 5K. This means that their coupon is now 20% because it has not changed in nominal terms. So, if the government wants money they have to issue bonds at 20% because if they issue them for less people will buy the existing ones instead. So, government and corporations that issue those bonds will tighten up their spendings and money will be more valuable. Using bonds as currency would make no difference at all.
