Government bond emission as a form of money creation
The role of state financing in steering economic activity
The theories of banking outlined previously involved money creation originating mainly through the active participation of private commercial banks in this process. Since in order to understand money, one has to understand banking as well. [1]
There is, however, another institution able to initiate the process of money creation: the government.
Prerequisites:
there must be a generally accepted means of final settlement available, i.e. money in circulation — before it can get taxed: ‘the government spends first, and taxes later’: [2]
“Once the government levies a tax, the private sector needs the government’s money so that it can pay the tax.” [3]
hence, public sector indebtedness is the source of private sector wealth: [4]
The government bond emission process:
Government bonds are issued by way of tendering in the so-called primary market with an exclusive group of entitled bidders, i.e. large commercial banks.
Bonds will initially be deposited in the accounts of the respective central bank.
From there the bonds will be allocated and charged as a liability to the central bank accounts of the members of the bidding group in accordance with the result of the tender procedure.
The bonds will then in the same instance be credited to the government’s central bank account.
Bookings at the sale of government bonds:
For the member banks of the bidding group this transaction will be booked as an asset swap. The position of securities increases in the amount of the acquired government securities whereas the credit amount on their central bank accounts decreases by that amount.
At the central bank this will play out as a liability swap: the credit amount at the bidding members’ central bank account decreases, while the credit account of the government increases by that amount.
The revenue from the bond emission are at the government’s disposal. The liabilities are accounted in the government’s debt register.
Effects on the monetary circuits:
The above presented transactions were exclusively handled in central bank (settlement) money.
Government securities were sold to the members of the entitled bidding group with central bank money (i.e. deposits at the central bank) and the government finds an increased account balance at the central bank after the conclusion of the sale. At this point no money creation has happened yet.
In the moment, however, the government proceeds to make use of the deposits on its central bank account for the financing of its tasks (be it the development of transport infrastructure, social security, decarbonisation of the economy, etc.) those funds move to the accounts of commercial banks. Through these transactions new bank money, i.e. checkbook money, is being created.
The above explanations are adapted from an official publication by the Scientific Service of the German Parliament. [5]
Sources:
[1] Keen, S. (2022) The New Economics: A Manifesto, Cambridge: Polity.
[2] Kelton, S. (2020) The Deficit Myth: Modern Monetary Theory and How to Build a Better Economy, London: John Murray (Publishers).
[3] Mosler, W. (2012) Soft Currency Economics II: What Everyone Thinks They Know About Monetary Policy Is Wrong, 2nd ed., Christiansted: Valance.
[4] Peccatiello, A. and Keen, S. (2023) The Government Deficit Myth: This Is How The Government Prints Money, [online] available on Youtube, starting from minute 5:00.
[5] Wissenschaftliche Dienste des Deutschen Bundestags (2020) Verfahren und Wirkungen bei der Emission von Bundeswertpapieren, [online] available at: <https://www.bundestag.de/resource/blob/817896/0e5f603c0bd9ce9680418abfadc322b6/WD-4-129-20-pdf-data.pdf> [Last accessed 25th March 2023].