Thread by @R2Rsquared

*** Monetizing the debt

When a country faces a large sudden expense with strains on economy and financial sector, the government massively borrows. Debt markets can't absorb new debt, so the central bank steps in. Is debt being monetized and will inflation soon follow?
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The Fed, the Bank of England (and many more) have been buying lots of government debt. To pay for it, they credit the account of banks at the CB. So the banks:
- buy bond from Treasury
- sell it to CB
- get an IOU from CB as digital entry in deposit account at the CB.
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No currency is printed. The CB has assets (the government bonds) and liabilities (the deposits of the banks). Its balance sheet blows up. In modern times, we call this quantitative easing (QE). The CB chooses the interest rate to pay on deposits.
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bit.ly/3cqnyYs

Inflation is determined by many factors including expectations. But to first order QE does not by itself generate inflation: it does not change amount of currency in circulation, the interest paid on deposits, the total amount of govt liabilities
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bit.ly/3akMIq7

Is this monetizing the debt? It depends on what you mean by money and debt. Deposits at the CB are money. But, they are also a debt of the State. And, since 2007, they pay an interest rate that is approximately the same as the short-term bond rate.
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bit.ly/2RKRMh6

Current CB actions don't relax budget constraint of the govt intertemporally. The govt still has to collect future taxes to pay for debt. The CB will collect and pay the banks. Public finance fundamentals did not change. CB just made borrowing easy
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Whether we are monetizing the debt now depends on *future* actions. That are to be chosen. They depend on the CB and on the Treasury. There are many cases that especially depend CB independence and its financial stability relative to the Treasury
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Case 1, common after wars:
The CB has a ceiling on LT interest rates to make paying the debt outstanding cheaper. This was the case in US in second half of 1940s. We will have inflation and/or deflation, no longer an inflation target or anchoring
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Case 2, classic debt monetization:
Treasury does not pay back bonds the CB owns. CB makes loss, bank deposits exceed its assets. CB is insolvent in economic sense. Banks ask to exchange deposits for currency, CB prints currency, we get inflation.
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bit.ly/3bk23Zj

Case 3, Treasury defaults on privately-held debt:
Banks are insulated from default, because bonds default but deposits at the central bank do not. QE then determines size of default, its composition, and its implication for financial stability.
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Case 4, CB inflates the debt.
Bondholders see it, are unwilling to hold LT debt. CB forces them to via regulatory power (repression). Bankers lobby for interest-rate ceiling on checking accounts. Losses passed on to poor depositors (US 1970s)
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Many more cases, I could keep going. But they all depend on the *future*. So: is the explosion in the CBs balance sheet a sure sign of monetization of the debt and of future inflation?

No.

It might. Or not. It depends on the monetary and fiscal policy that will follow
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