Do Central Governments Need To Issue Bonds (Again)?

The old "should the government issue bonds" debate has come up again. I would point the reader to this article at Mike Norman Economics, as well as the Richard Murphy article it refers to. I would argue that there is limited room for debate. The Treasury of the central government certainly can stop issuing bonds, conditioned on there being changes to the legal/regulatory framework for the central bank. The more important question is whether such a policy is a good idea. My argument is that doing so would run into a variety of consequences, and other policy decisions would need to be rethought (mainly the structure of pension provision).

I have written about this before, and will therefore keep this article short. In particular, I discussed this in Section 6.7 of Understanding Government Finance. I just want to respond to this statement by Richard Murphy:

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.

Whether or not the Treasury issues bonds is not a "contradiction" of Modern Monetary Theory (MMT). Certainly that is a policy proposal that has been put forth. However, I would argue that it is a secondary policy issue. (I certainly have a bias in this matter - I just published a book on inflation-linked bonds, which are almost entirely issued by central governments.) There would be ramifications of such a policy shift, and we would need to address those issues at the same time.

Is it Possible? Yes!

It is not hard to find people who argue that suspending bond issuance is impossible because it would run afoul of some particular operating rule under current law. Which is a remarkably silly response. Abolishing bond issuance by the Treasury is a policy proposal. One amazing empirical regularity of policy proposals is that they invariably seem to propose changing policies.

(As a technical note, this discussion does not apply to all "government" bonds; sub-sovereigns would probably have to issue bonds.)

The easiest way to get there is for the Treasury to switch to running an unlimited overdraft at the central bank. Whether or not it pays interest on that overdraft is not material: all the interest income gets swept back to the Treasury anyway!

This does not mean that there will not be central government securities. Currently, there are entities that need default risk free assets, and only the central government can supply them. The ugly solution is to allow entities to bank directly with the central bank. However, this puts the central bank in direct competition with private banks for providing financial services to the non-bank sector. A simpler solution is to issue bills on a fixed price basis. That is, sell unlimited amounts of bills at a fixed yield. This is similar in concept to savings bonds, but they are securities that can be traded in the secondary market. The central bank could be the entity issuing the bills.

Some readers may have concerns about "money printing." These concerns are entirely ideological; we cannot differentiate the proposed system from the existing system within most mathematical models of the economy. The only difference is the intra-governmental accounting, which has no effect on the behaviour of entities outside the central government.

Policy Impact

There would be a number of side effects of such a policy.

• Prudential financial regulations that refer to Treasury bonds would need to be revised. Since banks can hold settlement balances ("reserves") at the central bank, the banking system should largely be unaffected.
• Non-bank entities that require risk free assets will need some mechanism to directly hold government liabilities. It will be inefficient to force them to use bank intermediaries to get safe assets, since the patterns of banker behaviour are well documented.
• From a Minsky-ite perspective, the loss of Treasury bonds will be dangerous for private sector portfolios. The fact that Treasury bonds increase in price during a financial crisis is a key factor propping some entities' balance sheets, giving them the buying power to intervene and stabilise the markets in private sector liabilities.
• We live in environment where pension provision has been pushed onto individuals. Taking away the only easily understood source of safe assets will make personal pension planning even harder. (Pension and insurance funds need safe assets, and Treasury bonds are extremely useful for their portfolios, as noted in the previous point. However, one might hope that they would have the sophistication to find "safe" private assets, although 2008 showed the limits of such "sophistication.")
• As a technical addendum to the previous, almost 100% of the supply of inflation protection comes from central governments (Section 4.6 of Breakeven Inflation Analysis).
• Abolishing bond issuance would largely imply a loss of control of the risk-free interest rate, unless the central bank starts issuing long duration instruments. Although this is not a major concern of MMTers -- who mainly are argue that the effects of interest rates on the economy are mixed -- the reality is that a significant majority of economists (and market participants) believe that interest rate policy is crucial. Losing that policy lever would be a massive political fight, with extremely limited gains. The compromise I would push for is to dump interest rate control in the hands of the central bank, and let them take the political heat for their mistakes.

One might hope that the private sector can sort out the safe asset issue (I have serious doubts), but pension provision is an extremely important question. We have a very large cohort of people in retirement needing guaranteed cash flows. (It would have been a lot easier to muck around with pension policy in the 1960s-1970s, when the population was weighted towards youths.) Although I am not a fan of the policy trend to push pension provision into the hands of individuals, there is no obvious policy fix at present. I see serious political or implementation issues with almost any proposal at this point. Obviously, there can be improvements, but those improvements will likely be highly jurisdiction-dependent.

Concluding Remarks

There is no doubt that central governments can stop issuing Treasury-backed bonds; the question is how to deal with the side effects of the policy.

(c) Brian Romanchuk 2018