macroeconomics, money-supply, central-bank, interest-rates, bondsAs far as I understand it, the central bank of a sovereign state (like the Fed) prints money and loans it to the private banks, which have to pay the prime rate.
In another money exchange process, private institutions buy government bonds, thereby lending their money to the government, who use the money to finance the state’s deficits and debts.
So, one could think the government could be tempted to make the central bank print money and lend it directly to the state’s treasury. This could make sense because of the following reasons:
I suppose the number one reason why a central bank does not do such a thing is that it would undermine the credibility of their currency. But hopefully someone can provide a more accurate answer.
(I’m currently not interested in the context of cases like the Eurozone where we do not have a 1:1 relationship between the sovereign state and the central bank. I’m talking about “classical” cases like the U.S., UK or Switzerland).
That’s exactly what’s been happening with the quantitative easing programmes that have been undertaken by the Federal Reserve, the Bank of England and the Bank of Japan. In more normal economic conditions it would be inflationary, as it represents a drastic loosening of monetary policy.
Your intuition is correct. When the central bank buys government bonds with newly created money, what really happens is that the debt is redeemed at the expense of all currency holders (as opposed to the tax payers). So, naturally, this makes the currency less attractive as reserve currency or to conduct international transactions. Also, there’s another problem with financing the debt in this way, which is that taxes usually are progressive (the wealthy pay more in proportion to their wealth) whereas inflation is equivalent to a flat rate tax (everybody pays proportionally to the amount of money they have) and this could be seen as unfair.
All content is licensed under CC BY-SA 3.0.