Proponents of Modern Monetary Theory claim that bond sales are unnecessary and only help central banks set interest rates (which should be 0% anyway according to theory) and to provide safe interest-generating assets to investors. Yet according to the general principles of the theory, bond sales have a similar effect to taxation in removing money from the economy and keeping inflation under control. So I don't get why they claim issuing bonds is entirely pointless, it seems to me that they do add to a government's non-inflationay funding capacity. So what's the deal here?


2 Answers 2


Bill mitchell explains it pretty well in this link. For me the quickest answer is that paying interest on excess reserves achieves similar objectives as bond sales, more or less http://bilbo.economicoutlook.net/blog/?p=43017

  • $\begingroup$ Hi, thanks for the swift reply, I'll check your link out and come back to you if I need further clarification. $\endgroup$ Dec 27, 2022 at 23:58
  • $\begingroup$ Before, I read and reread Bill's post, doesn't creating even more money out of the blue on excess reserves interest on top of monetized deficit spending add even more money printing? Wouldn't the exchange rate suffer from such an unconventional policy, especially for a developing country? And who would set the interest rate on reserves? $\endgroup$ Dec 28, 2022 at 0:11
  • $\begingroup$ The interest rate on reserves is set by Fed policy in the US. The policy of replacing bond sales by Fed deposits would create more inflation only if the holders of those deposits were more likely to spend money than if they owned Treasury bonds instead. Which is sort of unclear. $\endgroup$
    – dm63
    Dec 28, 2022 at 0:40
  • $\begingroup$ Could developing countries do that without a risk for the exchange rate of their currency? $\endgroup$ Dec 28, 2022 at 0:52
  • $\begingroup$ It’s a rather hypothetical question. I’d say it would be more difficult in a country where the central bank is not well trusted. $\endgroup$
    – dm63
    Dec 28, 2022 at 13:53

I think there is some confusion over how Government spending operationally occurs. The below is a very high-level overview.

When monetarily-sovereign Governments spend on their priorities, they increase the level of bank reserves in the system. In order to make payments to their final recipient (i.e. the seller of their good, service or labour), the banks that hold these reserve accounts at the central bank increase the deposits held by these sellers with each bank to match the increase in reserves.

The result is a seller with increased financial assets (in the form of bank deposits), a commercial bank with both increased liabilities (the deposits it now owes the seller) and increased assets (the reserves that the central bank credited them with initially when the Government spent), and a Treasury which is debited by the amount spent (putting it in "overdraft").

Taxes reverse this process by draining both deposits and reserves.

However, if a Government runs a deficit and there are both excess deposits and excess reserves in the system, issuing Government bonds only mops up the excess reserves.

The additional deposits in bank accounts are still there and available for spending.

This is why issuing Government bonds is not to combat inflation but to address reserve liquidity and target a particular short-term interest rate (although there are questions as to the neccessity of this operation in high rate environments when debt interest represents a large transfer of financial assets from the bottom of the income distribution to the top).

  • $\begingroup$ Hi @Jamie Smith. Nice answer. Could you provide some references to this kinda monetary/fiscal interaction, please? I've often found it hard to find. $\endgroup$
    – EB3112
    Sep 19 at 12:11
  • $\begingroup$ Hi @EB3112, thanks. I've found this paper by UCL very enlightening: ucl.ac.uk/bartlett/public-purpose/publications/2022/may/… Also, the GIMMS website has fantastic resources to edcuate people of all levels about monetary reality: gimms.org.uk $\endgroup$ Sep 20 at 7:58
  • $\begingroup$ Hi @ Jamie Smith. Great UCL reference! thanks $\endgroup$
    – EB3112
    Sep 20 at 9:00

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