Government Bonds, Spending, and Money Creation: Rethinking Their Roles

Money Creation. The concept of money creation, or "printing new money," refers to government spending and loan creation in banks. Both activities generate deposits in the bank accounts of individuals or firms, representing new money circulating in the economy. This process of money creation is essential for fueling a healthy economy, but it must be carefully managed to avoid excessive inflation.

Government spending results in (1) deposits in recipients' accounts, such as pensioners, civil servants, or the suppliers of goods and services to the government, and (2) in reserves of banks deposited with the central bank. This creates new money. Similarly, when banks approve a new loan—an asset for the bank—they create new money, which appears as new deposits for the client granted the loan—a liability for the bank. To cover for these deposits, which can be withdrawn or transferred to another bank, the bank needs to maintain sufficient liquidity. This liquidity is provided either by government spending (the mentioned bank reserves) or by borrowings from the central bank.

The Role of Government Bonds. Government bonds play a crucial role in financial systems worldwide. These bonds, primarily purchased by banks, act like "savings accounts" for the banks. Banks buy these bonds to deposit their excess funds—money created by government spending. Offering a secure means for banks to deposit their liquid money, government bonds provide higher returns without risk.

The government uses these bonds to regulate the economy through interest rates. Higher interest rates on government bonds encourage banks to store their liquid money, rather than lending it. Conversely, lower interest rates incentivize banks to lend more.

Furthermore, government bonds are offered in a variety of term lengths. This variety allows banks to hedge against interest rate risk, which can occur due to differences in the term lengths of their loans and deposits.

Money Circulation. The circulation of government bonds inside and outside banks must maintain a delicate balance. If the bonds remain in banks’ ownership, they do not reduce money circulating in the economy. However, if the bonds are further sold to individuals and firms, then money in circulation is reduced, as individuals or firms use their deposits or cash to purchase the bonds. Consequently, this reduces pressures on consumer prices.

The tax system works in conjunction with government bonds. Taxes primarily serve to create a demand for state money and redistribute wealth. Additionally, both taxes and government bonds control money circulation as taxes also remove money from circulation.

Government Spending: A Matter of Social Convention. Society has established rules aiming to make the government spend responsibly, namely that each government expenditure must be covered by a tax or a bond. This creates the impression that taxes and national debt finance government spending, but it is merely a social convention, not an economic necessity.

In reality, governments spend without needing taxes or bonds in advance. If taxes do not cover government spending, governments issue bonds that are bought by banks. Banks demand state bonds because they provide a form of "savings accounts" and also help manage interest rate risk.

However, these rules are not immutable. We do not need taxes or bonds to finance government spending. The spending capacity of governments is not inherently limited. The restrictions that the government faces are those that we have established by law. But laws can be changed. We could find another way to make the government spend responsibly - for example, through a constitutional law that would guarantee every citizen an unconditional basic income financed by the "printing of new money". If society collectively decides to fund something, such as an unconditional basic income, without corresponding taxes or bonds, it is entirely possible. We argue that if this is done wisely with regard to the capacity of the economy, it will be beneficial to society.

Conclusion. It is time to reevaluate our current public finance rules. We should fund an unconditional basic income while considering the capacity of the economy to maintain price stability. Understanding that taxes and bonds are not sources of funding, but serve to fulfill this goal. By changing our current financial paradigms, we can create an economy that is more inclusive, fair and prosperous for all.

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