Thursday, 20 October 2016

How are Government Bonds created?

and it doesn't have to be this way!

There was a brilliant article on  Independent Australia on 5th Oct 2016 by Iain Dooley, ‘We once had full employment and we could do it again’.  Most enlightening but it did raise a question for me on how Government Bonds are created; Iain replied at length and in the same vein as his article – very educational. Here is answer to me
Iain Dooley 

Great question. Bonds are a funny vestige of commodity money systems of the past and nowadays they can be thought of as similar to term deposits at the RBA. Since Government Treasuries are sufficiently liquid to satisfy private banks' capital adequacy requirements there is functionally very little difference between bonds and reserves except that bonds are an interest bearing asset.
 I made this video which describes how bonds are not really a borrowing operation for a monetary sovereign and they are mostly issued to allow a central bank to set and defend a cash rate target: 

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However the reality of legislation in Australia currently does mean that when the government deficit spends it is required to "finance" this spending through the sale of bonds.
 The reality is that this just gives the RBA enough leverage the soak up excess reserves and set the interest rate through open market operations but if you call up the AOFM they will tell you point blank that new bond issues on the primary market are required to "finance the deficit".
 It's a completely self imposed constraint but it does make the task of communicating the fact that a monetary sovereign like the Australian Federal Government is not fiscally constrained when even those working at these institutions don't understand the reality of the situation.
 However even within this convoluted system of self imposed constraint the reality is still that deficit spending by a treasury creates net financial assets in the private sector and that these assets are virtually indistinguishable from reserves. 
I therefore made a second video demonstrating how our system is currently configured and how the treasury creating bonds "out of thin air" is no different from treasury creating reserves out of thin air: see 5 minute video 

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You can check out more videos on our YouTube channel or review all the MMT, Modern Monetary Theory,  explainers in a single playlist:Nine easy lessons explaining MMT


Thanks very much for checking out the article and taking the time to comment.
Iain Dooley

Iain is co-founder of the Australian Employment Party ;here is his article in full we once had full employment

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