Summary:
I wrote this in June. In the light of my blog on modern monetary theory today and the comment I made in it that the government must act as the borrower of last resort I think it appropriate to republish it. I do so knowing it contradicts modern monetary theory. Political judgement and the needs of financial markets suggests that doing so is appropriate for the reasons I note. Modern monetary theory is not, in other words, the answer in all cases: it can just inform the process in which a government decides to engage…
While MMT holds that governments do not need to issue bonds, MMT does not hold that government's should not issue bonds. MMT only holds that bond issue is not necessary operationally for funding deficit spending. Therefore, bond issuance may constitute a subsidy for savers
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While MMT holds that governments do not need to issue bonds, MMT does not hold that government's should not issue bonds. MMT only holds that bond issue is not necessary operationally for funding deficit spending. Therefore, bond issuance may constitute a subsidy for savers unless issuance can be justified on grounds other than funding.
Some MMT economists recommend retaining bond issuance for reasons other than funding. For example, the issuance of safe assets contributes to the stability and operation of the financial system, and it protects ordinary savers, e.g., through pension systems. In the US, individuals can purchase Treasury securities through
Treasury Direct.
In addition, like the policy rate, the rates along the yield curve serve as benchmarks.
So, issuance of government securities plays other roles than funding.
In short, safe assets bearing some interest reduce risk in the system to some degree. For example when the ratio of public debt to private debt is higher, systemic risk is lower. And owing to the safety factor, savers are willing to accept lower rates on public debt than private debt. This serves as a check on accumulation of private debt. This is significant in the financial cycle based on Minsky's financial instability hypothesis, for instance.
From the operational standpoint, a government could choose to issue only settlement balances in the payments system and set the policy rate to zero. But this may not be the only factor or even the chief factor. It is a matter for debate whether a government is best advised to do this.
If iit is decided to issue bonds, then a governments should tie securities issuance to the deficit but rather issue securities to meet demand for safe assets. There is no operational need to limit securities issuance, and in spite of conventional views, bond issuance doesn't reduce the putative inflationary effects of government currency issuance through spending appropriations.
In the case of continued bond issuance, interest rates along the yield curve would have to be kept low enough not to compete with investment funding by encouraging saving over investment. That is, interests rates on longer term securities would have to be lower on average than the profit rate.
MMT economists recommend that the current monetary policy of raising the policy rate to "control inflation" by increasing yields toward the profit rate should be abandoned in favor of functional finance, pointing out that monetary policy is a shotgun approach while functional finance is a targeted one. In addition, monetary policy favors savers over borrowers and the current approach to monetary policy based on NAIRU uses the inflation rate as a target and the unemployment rate as a tool, disadvantaging workers.
Functional finance aims at achieving optimal growth, actual full employment and price stability using fiscal policy based on automatic stabilization and a job guarantee that also works as a price anchor. MMT economists have developed a considerable literature articulating this approach, which they admit is not original with them. Rather, it has been dismissed by conventional theory with conventional economists asserting that the methodological debate is over as justification for ignoring heterodox theories and policy proposals based on them.
Choices involve tradeoffs. In policy formulation, if options are divergent, it becomes a political question. Regarding bond issuance, there are arguments on both sides of whether to issue bonds. There is not unanimity among MMT economists on this issue.
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