Interest Rates and ‘Reserve Constraints’: Why Endogenous Money Works Without Central Bank Intervention


Endogenous money advocates often think that a central bank is required in order to offset increases in government borrowing. The story goes: the central bank targets the overnight interest rate by buying up government securities; if the government issues more debt in the form of securities to increase spending the central bank will soak this debt up to maintain the target interest rate. Thus government spending cannot cause higher interest rates. Rather the interest rate is set by the central bank.

This is a nice story. I tell it myself sometimes. It is easy to communicate and it usually causes anyone arguing otherwise to pipe down. But there is a much simpler and more fundamental argument for endogenous money. It is the one that we can use to explain the historical statistics in various countries. Let us turn to these first.

Now, we know today that the central bank targets a rate of interest and buys government securities but it is not so clear that this is what happened in, say, Britain in the 19th century. They operated under a gold reserves system and the central bank had not yet articulated its own role as setting the rate of interest. Yet, the Bank of England have clearly shown in a fantastic paper entitled The UK recession in context — what do three centuries of data tell us? that government borrowing in the UK never really affected bond yields. Take a look at the graph below from the paper.


See that red circle? Well, that is an era in which government deficit-financing is rising enormously while the interest rate on bonds… falls! That seems somewhat at odds with the hoary old tale that rising government spending not backed by rising taxes leads to a ‘crowding out’ of investment and hence a rise in interest rates now doesn’t it?

So, how do we account for this? Well, it is quite simple really: when the government sells securities to the private sector the money that it receives gets spent back into the economy. This means that it accrues in someone else’s bank account. Thus the net amount of reserves in the system does not actually change. The effects on interest rates come from another sector entirely. Let us first look at the above statement in more detail.

Imagine that the government wants to borrow £100 to pay a policeman. It will issue £100 of government debt to a primary bond dealer and receive £100 in cash from him. It will then pay the policeman the £100 which will accrue to his bank account. So, the financial assets excluding cash in this period will look like this (with [-] denoting a liability and [+] and asset):

Financial assets not including cash

Government: -£100

Primary bond dealer: +£100

Policeman: -/+£0

As we can see the primary bond dealer’s financial assets (excluding cash) have increased while the government’s financial assets (excluding cash) have decreased. The policeman’s have stayed the same. What about the cash? Well, the balance sheets for cash will look like this:


Government: -/+£0

Primary bond dealer: -£100

Policeman: +£100

Now we know that the primary bond dealer’s cash has been depleted by £100 and the policeman’s have been increased by £100. Meanwhile the primary dealer’s financial assets (excluding cash) have increased by £100 and the government has incurred a liability of £100.

The total amount of private sector cash savings remains identical to before the transaction. Because the government spent the money it borrowed back into the economy it effectively just transferred cash savings from the primary bond dealer to the policeman. This means that if a private company want to borrow they will find the same amount of money in existence as before the government undertook the transaction. They will just have to approach the policeman (or his bank) rather than the primary bond dealer if they want to borrow it.

Another way to put this is that: deposits remain the same. The primary dealer loses a bank deposit and the policeman gains a deposit. And if the aggregate level of deposits in the banking system remain the same then why would there need to be an increase in bank reserves to accommodate? Simple answer: you don’t. This is where the money multiplier becomes a sort of fallacy of composition. Reserves are held against deposits, so if deposits in the aggregate remain the same then there will be no need to increase reserves in the aggregate to accommodate the lending and borrowing. In the example we have given shows the borrowing by the government does not increase deposits. Deposits remain the same.

Where do the potential effects on interest rates come in then? Simple. The stock of government debt has increased. In a typical supply and demand market if the quantity of a good increases its price falls. So, if the quantity of government debt rises then its price should fall and its interest rate should rise. This could, in principle, drag up interest rates on other securities and cause a general rise in the rate of interest (this is by no means clear but it is a possibility).

So why then did the yield on government debt in the UK in the early 19th century fall as the stock of government debt rose? Quite simply: confidence. People had confidence in British public debt since the Bank of England was established in 1694. (See here for a potted history). People didn’t much care that the stock of public debt was rising because they believed it would be paid off. So, even though the government ran up massive debts and massively increased the supply of government securities the price on these securities remained the same. This was likely helped to some extent by increases in savings held by exporters (but the current account surplus in this era was by no means large enough to explain this alone).

That is not how financial markets work. They are not price versus quantity markets. Rather they are price versus perceived risk markets. And this ties back into Keynes’ theory of financial markets. To put it very briefly: if people are highly confident in the financial markets and there is a fixed amount of money in those markets the velocity of the money in the financial markets can speed up to accommodate any increase in the flow of borrowing. This is actually very obvious but mainstreamers don’t dig very deep into these things generally.

This blog post is long enough but I have fully formalised Keynes’ theory in the book that I am nearly finished writing. I think that this is the first time it has been done. Since I have given more than enough content away on this blog for free you will have to wait until it comes out, buy it and then you can get a better grasp on Keynes’ theory; the only theory that really fits with the historical record in this regard.


About pilkingtonphil

Philip Pilkington is a macroeconomist and investment professional. Writing about all things macro and investment. Views my own.You can follow him on Twitter at @philippilk.
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56 Responses to Interest Rates and ‘Reserve Constraints’: Why Endogenous Money Works Without Central Bank Intervention

  1. “That is how financial markets work. They are not price versus quantity markets. Rather they are price versus perceived risk markets. And this ties back into Keynes’ theory of financial markets. To put it very briefly: if people are highly confident in the financial markets and there is a fixed amount of money in those markets the velocity of the money in the financial markets can speed up to accommodate any increase in the flow of borrowing. ”

    Its both. Markets run on perceptions and demand/supply. It just depends which force is stronger.

    You can see a positive correlation between debt/gdp and the interest rate from 1700 til half way through red circle (except for 1715-1725) and the first couple of recessions of the 1900’s.

    • Yup. Check the history. It’s perceived risk. The event that led to the fall was the creation of the BoE. This is well documented these days.

      • philippe101 says:

        you’re right that the examples I gave in my comments in the other thread were ceteris paribus…

      • philippe101 says:

        I think you should both stop being dicks to each other and just have a sensible debate with less insults.

        I think you probably started it though, by repeatedly dismissing everything that economists like Pontus do as being total garbage (etc).

      • philippe101 says:

        I don’t think Pontus is an incompetent. I think the debate between the mainstream and heterodox on this sort of subject is complicated, and whilst it seems to me that the mainstream view is wrong in some respects, I wouldn’t dismiss it out of hand as being worthless.

      • My point was that the markets are price versus quantity markets sometimes and sometimes not just depending on which force is bigger.

    • philippe101 says:

      Well he’s a sort of mainstream economist who engages with post-Keynesians a lot, and that’s quite unusual, and not boring. He acts like a troll on your site sometimes, probably because you troll him by declaring that everything he and other economists like him have ever done is basically worthless.

    • philippe101 says:

      maybe he thinks the same thing about you?

      I don’t want to excuse anyone’s poor behaviour, but why not try to keep the debate civil.

      Given that you can edit comments on this site, why don’t you just delete all insults that people leave, whilst keeping the substantive parts of their comments. Then you wouldn’t feel like you have to respond in kind.

  2. NeilW says:

    Governments spend via a buffer stock of cash.

    So what happens, figuratively, is that the Policeman gets paid at 11am. This increases the amount of cash in the system. Government debt is than offered at 2pm – when there is more cash in the system likely to chase it.

    That then tops the buffer back up, and it helps keep the price of government debt down in the primary auction.

    The process is ‘inflate/deflate’ on the stock of cash released into the private sector.

  3. Pontus says:

    You are assuming that,

    1, Someone is hoarding cash (the primary bond dealer)

    2, That cash and government bonds are perfect substitutes (the bond dealer accepts government debt without any rise in the interest rate).

    So you are just describing the situation that I brought up in the previous thread (together with the accounting), which you, paradoxically, objected to.

    And yes, I’ve claimed all along that if cash is idle (I called it excess reserves, but that’s just semantics — same with the notation ‘x’ previously), or bank rate is constant, government spending can increase nominal demand by borrowing (or taxing, mind you). Simply because more money is being circulated.

    • (1) No I didn’t. If someone was ‘hoarding’ cash then by definition they wouldn’t be willing to invest in government securities. Duh.

      (2) No I didn’t. That’s why I put up a graph mapping the interest rate! Haha! 😀

      • Pontus says:

        “It will issue £100 of government debt to a primary bond dealer and receive £100 in cash from him.”

        So where does the bond dealer get the £100 in cash? And how come he is willing to hand the cash — wherever he got it from — over for a bond (that he wasn’t intending to buy at going interest rates in the first place)?

      • It’s cash that is waiting to be invested in… anything. I didn’t specify. If you don’t think that there is cash available for investment in a given economy at any moment in time then I really can’t help you. Sorry.

      • Pontus says:

        Ah, I see. The primary bond dealer was ready to purchase £100 of investment goods, but abstained because of the government’s intervention. This reduces demand for investment goods by, wait for it, £100. So what is the net effect on demand? Or are you claiming that the reduction in investment had no consequence on the economy?

      • Wrong again. Catch up Pontus! The private investor can approach the policeman’s bank for the money. I stated that clearly.

      • Pontus says:

        What does “The private investor can approach the policeman’s bank for the money” mean?

        If it means that the private investor can borrow money from the policeman (or his bank) and still make the investment, you’re guilty of double counting: the government spends once, and then the investor borrows money from the policeman and spends on investment. With that timing convention you might as well have said that the investor could have made the investment, and the recipient of the invested fund would, in turn, have spent the received funds.

        It seems to me you’re assuming that the government has some sort of warp-speed spending ability that dwarfs the private sectors’.

      • The same is true of the private sector, yes. It is only when people borrow money and do not spend it (hoarding) that the aggregate amount of money in the banking system falls. But that is Keynes’ liquidity preference theory, of course.

      • Pontus says:

        Well, you’re claiming something different, aren’t you. Your claim is that the government can borrow from the investor, spend, increase income for the policeman who then spends again (or lends to the investor who then spends). But how is this different from the investor spending which goes to the construction worker who then spends again? You claim it is, but I have yet seen any convincing arguments for this.

      • It is not different. I’ve said that twice now. You’re lost, dude. And I’m not interested in helping you find your way.

        Tell me when you’re presenting on macro again. I’m always game for a laugh. Peace.

      • Pontus says:

        Then you are actually dumber than I thought.

        If there is no difference there is full crowding out, as the government’s action had zero impact on the economy relative to the counterfactual. How come there is full crowding out? Because the government persuaded the investor to not pay the construction worker, but instead pay the policeman. In mainstream economics that persuasion is carried out through a rise in the interest rate for government bonds. You seem to argue something different, but there is still full crowding out. How very neoclassical of you, Phil.

      • Pontus says:

        Nice ego-saving exit, Phil. But changing the topic doesn’t fool anyone.

        Explain then how you can say that there is no difference between the situations, but there is still no crowding out!?

        Next scheduled public appearances: Sept. 10 at Bank of Spain and Sept. 18 at National University of Singapore. You probably need to request access in advance for security reasons, but I’m sure you are welcome. Please come, it would be an honor to have you in the audience.

      • Pontus says:

        Oh Phil. Attacking the challenge head-on I see! … Given that your idea of attacking a challenge is ad hominem attacks and insults.

        So you have no answer. Good for us to know. I wasted my time on a charlatan, but at least he is exposed as a charlatan so something good came out of it.

        (Btw. what these “other people” say about me, I don’t give a rats ass, so be a big boy now and stop repeated those silly accusations. It makes you look like an idiot.)

      • I’m more than happy to discuss the issue with ivansml. What he is saying is coherent. You’re in the “not even wrong” camp. It’s like playing chess with a chimp. Not worth the time of setting up the board.

        And again, make sure that you don’t concern yourself with what other people think. Again, the truth in that matter will not set you free…

      • philippe101 says:


        “Ah, I see. The primary bond dealer was ready to purchase £100 of investment goods, but abstained because of the government’s intervention. This reduces demand for investment goods by, wait for it, £100.”

        The investor can still spend £100 on investment goods. Buying a government bond does not reduce his ability to spend on investment at all. All he has to do is sell the bond, which he can do very easily. Or he can use it as collateral.

      • Pontus says:


        Selling it doesn’t help as someone else is buying it (and therefore not engaging in their planned activity which would add to demand). If you see the private sector as an entity, which is a useful abstraction in this case, it becomes obvious that the private sector cannot sell to itself. So that’s a dead end.

        Using it as collateral to take a loan brings us back to the situation Phil is actually arguing against: Sure, they can, but this will either push up the interbank rate such that no additional money will circulate (which leads to a zero rise in nominal demand), or there is an expansion in reserves (which is monetary policy).

      • philippe101 says:

        I read a very interesting text by Alexander Hamilton on this very subject a while ago. I’ve posted the quote at the bottom of this page.

      • philippe101 says:


        “So where does the bond dealer get the £100 in cash?”

        Originally that cash must have come from the government. Either someone borrowed it from the central bank, or the central bank previously bought government bonds from the private sector (which means that the government must have run a deficit previously), or the government spent the money into circulation (i.e. ‘money-financed’ deficit spending. I would count fiscal actions by the central bank in this category).

        If the private sector borrowed the money from the central bank, how can it pay off the debt plus interest? The answer is that it can’t, unless the government deficit spends (for simplicity I’m assuming just a government sector and a private sector, including domestic and foreign).

      • philippe101 says:

        So, in order for the private sector to own that £100 cash outright (without a corresponding unpayable debt to the government), the government must have previously run a deficit.

      • philippe101 says:

        actually the debt is not ‘unpayable’ if the Fed or Treasury spend the interest back into circulation (or if no interest is charged at all of course). I think the rest of my comment is correct though.

  4. Pontus says:

    You should probably also take a look at:

    who has a different view of the same data.

  5. ivansml says:

    “The stock of government debt has increased. In a typical supply and demand market if the quantity of a good increases its price falls. So, if the quantity of government debt rises then its price should fall and its interest rate should rise. This could, in principle, drag up interest rates on other securities and cause a general rise in the rate of interest”

    And this is precisely the story behind the textbook crowding out argument, which has NOTHING to do with expanding monetary base or deposits. Since you say nothing further about it, I really don’t understand what exactly is your point here and what are you trying to argue against.

    Also, before concluding that government debt has no impact on interest rates, one would really need to do more thorough analysis than painting red circles on a chart. Just by eyeballing the chart, I can see several periods where the correlation is positive. And the standard story really speaks about real rate, so one would need to control for inflation, at the very least (but more likely for bunch of other stuff too, as crowding out is a ceteris-paribus claim).

    • Pontus says:

      Ivansml, do you mind emailing me? I think you could help me with some stuff. (don’t worry, I won’t out you to anyone)

      • ivansml says:

        Of course, no problem. Not sure about your address, but you can reach me at: ivansml (at)

    • (1) I’m not sure if that is the standard crowding out argument. Can I has links and validating quotes pleez? Make it from a fairly respected source. Thanks.

      (2) I was assuming that people knew that the inflation rate (famously) had no impact on nominal government bond yields in the 19th century. It was all over the place. See here.

      Remember this was not like today where we have inflation data. People genuinely were not fully aware if or to what extent their money was gaining or losing value. To think that bond investors were calculating the real rate is absurd. Anyway as I have shown elsewhere, the Keynesian argument is that inflation doesn’t affect nominal yields (which is again confirmed by this data). See here.

      (3) I see no period where there is a suggestion that rising deficit spending might be causing a rise in nominal yields. Could you please point me to them? Thanks.

      • I can’t read it. It’s behind a paywall. But Barro is not a reasonable source. So, I’d imagine that its pretty dodgy.

      • ivansml says:

        (1) With full employment and loanable funds, it’s immediate. In more general case, we have standard IS/LM story, can be found in any macro textbook or Wikipedia. G goes up -> output increases (IS curve shifts right) -> money demand goes up -> to restore equilibrium in money market, interest rate must increase to support relative shift in portfolio allocation between money and bonds (movement along LM curve).

        (2) I’m not familiar enough with UK monetary history, but sure, it’s possible that inflation played little role at that time. But in general you have shown no such thing, and looking at large comovements in nominal rates and inflation over second half of 20th century proves otherwise.

        (3) Approximately: 1725 – 1800, 1850-1900, 1920-1940

      • (1) We’re talking about financial crowding out. Not real crowding out (which no economist would deny exists).

        (2) Are you saying that the massive rise in deficit spending between 1800 and 1825 which was not accompanied by a rise in interest rates is not remotely interesting for the crowding out story? That is a strange claim.

        (3) I don’t see most of these. In the 18th century yields clearly fell as the debt ratio rose. In the latter half of the 19th century the government ran surpluses while the interest rate barely fell at all. In the 20th century the interest rate clearly rises before the rise in debt-to-GDP.

      • Pontus says:

        You seriously don’t have access to sciencedirect at Kingston?

        Barro is a full professor at Harvard and the editor of QJE. You might disagree with him, but dismissing his arguments before even reading them is just plain stupid. You can’t just read stuff from people you know you will agree with.

      • I’m not at Kingston.

        Barro’s work is well dodgy. Lot’s of the mainstream’s work is — usually the ones that hold really out there views (Fama etc.). You won’t impress me with titles. I know how to manipulate data just as well as the next guy.

      • ivansml says:

        (1) IS/LM story *is* about financial crowding out.

        (2) No, I’m not saying that. It’s an interesting observation. But a single data point doesn’t prove or disprove anything in a field as complex as economics.

        (3) In second half of 18th century (the clearest case), red line and blue line wiggle very closely together. Years where debt/GDP ratio increased were also years where nominal rates increased. Qualitatively, the similar thing happened in latter part of 19th century. Since both variables have different units, it’s hard to see what’s “barely” and what’s not.

      • (1) Sorry. I was referring to the first part of your comment. As to ISLM, this is not the same argument as I presented in the piece. In the piece it is assumed that the LM curve is flat.

        (2) That’s pretty evasive.

        (3) I think you’re seeing what you want to see, to be honest. That graph shows to any reasonable person very little evidence for crowding out. If you can’t see that then you’re wearing a pair of lenses that I would not even try to remove. This is often the case with mainstream economists and data. I often find that these things go beyond the communication barrier. It’s like talking to someone that is seriously religious about miracles or something like that. Pointless. I think we can end the debate over the data now, thanks. I’d prefer not to continue.

      • philippe101 says:

        “The stock of government debt has increased. In a typical supply and demand market if the quantity of a good increases its price falls. So, if the quantity of government debt rises then its price should fall and its interest rate should rise. This could, in principle, drag up interest rates on other securities and cause a general rise in the rate of interest”

        “And this is precisely the story behind the textbook crowding out” (Ivansml)

        So how do you explain the exact opposite happening in reality?:

      • Phillipe, they would explain that by expansionary monetary policy which is now the cookie cutter theory in the mainstream (as Pontus is demonstrating). But the case I make in the post is that you don’t need expansionary monetary policy at all. You can see that in the data from Britain in the 19th century. The fact of the matter is that financial markets are not subject to normal supply and demand dynamics. There is a hint of this in Keynes’ theory but it was never truly developed.

      • Pontus says:


        Because demand for bonds changes too …

  6. philippe101 says:

    Alexander Hamilton: Report on Manufactures (1791)

    It happens, that there is a species of Capital actually existing within the United States, which relieves from all inquietude on the score of want of Capital — This is the funded Debt [the public debt].

    The effect of a funded debt, as a species of Capital, has been Noticed upon a former Occasion; but a more particular elucidation of the point seems to be required by the stress which is here laid upon it. This shall accordingly be attempted.

    Public Funds answer the purpose of Capital, from the estimation in which they are usually held by Monied men; and consequently from the Ease and dispatch with which they can be turned into money. This capacity of prompt convertibility into money causes a transfer of stock to be in a great number of Cases equivalent to a payment in coin. And where it does not happen to suit the party who is to receive, to accept a transfer of Stock, the party who is to pay, is never at a loss to find elsewhere a purchaser of his Stock, who will furnish him in lieu of it, with the Coin of which he stands in need. Hence in a sound and settled state of the public funds, a man possessed of a
    sum in them [government bonds] can embrace any scheme of business, which offers, with as much confidence as if he were possessed of an equal sum in Coin

    The sum of the debt in circulation is continually at the Command, of any useful enterprise — the coin itself which circulates it, is never more than momentarily suspended from its ordinary functions. It experiences an incessant and rapid flux and reflux to and from the Channels of industry to those of speculations in the funds.

    There are strong circumstances in confirmation of this Theory.

    The force of Monied Capital which has been displayed in Great Britain, and the height to which every species of industry has grown up under it, defy a solution from the quantity of coin which that kingdom has ever possessed. Accordingly it has been Coeval with its funding system, the prevailing opinion of the men of business, and of the generality of the most sagacious theorists of that country, that the operation of the public funds [public debt] as capital has contributed to the effect in question. Among ourselves appearances thus far favour the same Conclusion. Industry in general seems to have been reanimated. There are symptoms indicating an extention of our Commerce. Our navigation has certainly of late had a Considerable spring, and there appears to be in many parts of the Union a command of capital, which till lately, since the revolution at least, was unknown. But it is at the same time to be acknowledged, that other circumstances have concurred, (and in a great degree) in producing the present state of things, and that the appearances are not yet sufficiently decisive, to be intirely relied upon. In the question under discussion, it is important to distinguish between an absolute increase of Capital, or an accession of real wealth, and an artificial increase of Capital, as an engine of business, or as an instrument of industry and Commerce. In the first sense, a funded debt has no pretensions to being deemed an increase of Capital; in the last, it has pretensions which are not easy to be controverted. Of a similar nature is bank credit and in an inferior degree, every species of private credit. But though a funded debt is not in the first instance, an absolute increase of Capital, or an augmentation of real wealth; yet by serving as a New power in the operation of industry, it has within certain bounds a tendency to increase the real wealth of a Community, in like manner as money borrowed by a thrifty farmer, to be laid out in the improvement of his farm may, in the end, add to his Stock of real riches.

    …there appears to be satisfactory ground for a belief, that the public funds operate as a resource of capital to the Citizens of the United States, and, if they are a resource at all, it is an extensive one….”

    Click to access rpt_manufactures.pdf

    • philippe101 says:

      the above section starts on page 11.

      • philippe101 says:

        Alexander Hamilton: Report on Public Credit (1790)

        It is a well known fact, that in countries in which the national debt is properly funded, and an object of established confidence, it answers most of the purposes of money. Transfers of stock or public debt are there equivalent to payments in specie; or in other words, stock, in the principal transactions of business, passes current as specie. The same thing would, in all probability happen here, under the like circumstances.

        The benefits of this are various and obvious.

        First. Trade is extended by it; because there is a larger capital to carry it on, and the merchant can at the same time, afford to trade for smaller profits; as his stock, which, when unemployed, brings him in an interest from the government, serves him also as money, when he has a call for it in his commercial operations.

        Secondly. Agriculture and manufactures are also promoted by it: For the like reason, that more capital can be commanded to be employed in both; and because the merchant, whose enterprize in foreign trade, gives to them activity and extension, has greater means for enterprize.

        Thirdly. The interest of money will be lowered by it; for this is always in a ratio, to the quantity of money, and to the quickness of circulation. This circumstance will enable both the public and individuals to borrow on easier and cheaper terms.

        And from the combination of these effects, additional aids will be furnished to labour, to industry, and to arts of every kind.

        But these good effects of a public debt are only to be looked for, when, by being well funded, it has acquired an adequate and stable value. Till then, it has rather a contrary tendency. The fluctuation and insecurity incident to it in an unfunded state, render it a mere commodity, and a precarious one. As such, being only an object of occasional and particular speculation, all the money applied to it is so much diverted from the more useful channels of circulation, for which the thing itself affords no substitute: So that, in fact, one serious inconvenience of an unfunded debt is, that it contributes to the scarcity of money.

        This distinction which has been little if at all attended to, is of the greatest moment. It involves a question immediately interesting to every part of the community; which is no other than this–Whether the public debt, by a provision for it on true principles, shall be rendered a substitute for money; or whether, by being left as it is, or by being provided for in such a manner as will wound those principles, and destroy confidence, it shall be suffered to continue, as it is, a pernicious drain of our cash from the channels of productive industry.

        The effect, which the funding of the public debt, on right principles, would have upon landed property, is one of the circumstances attending such an arrangement, which has been least adverted to, though it deserves the most particular attention. The present depreciated state of that species of property is a serious calamity. The value of cultivated lands, in most of the states, has fallen since the revolution from 25 to 50 per cent. In those farthest south, the decrease is still more considerable. Indeed, if the representations, continually received from that quarter, may be credited, lands there will command no price, which may not be deemed an almost total sacrifice.

        This decrease, in the value of lands, ought, in a great measure, to be attributed to the scarcity of money. Consequently whatever produces an augmentation of the monied capital of the country, must have a proportional effect in raising that value. The beneficial tendency of a funded debt, in this respect, has been manifested by the most decisive experience in Great-Britain.

        The proprietors of lands would not only feel the benefit of this increase in the value of their property, and of a more prompt and better sale, when they had occasion to sell; but the necessity of selling would be, itself, greatly diminished. As the same cause would contribute to the facility of loans, there is reason to believe, that such of them as are indebted, would be able through that resource, to satisfy their more urgent creditors.

        It ought not however to be expected, that the advantages, described as likely to result from funding the public debt, would be instantaneous. It might require some time to bring the value of stock to its natural level, and to attach to it that fixed confidence, which is necessary to its quality as money. Yet the late rapid rise of the public securities encourages an expectation, that the progress of stock to the desireable point, will be much more expeditious than could have been foreseen. And as in the mean time it will be increasing in value, there is room to conclude, that it will, from the outset, answer many of the purposes in contemplation. Particularly it seems to be probable, that from creditors, who are not themselves necessitous, it will early meet with a ready reception in payment of debts, at its current price.”

      • philippe101 says:


        bearing in mind that the above was written in 1790, I thought the following was of interest in relation to your post:

        “The interest of money will be lowered by it [the public debt]; for this is always in a ratio, to the quantity of money, and to the quickness of circulation. This circumstance will enable both the public and individuals to borrow on easier and cheaper terms.”

        The exact opposite of the financial crowding out hypothesis… public debt can add to the stock of financial capital and lower interest rates, even in a relatively undeveloped economy with a gold/silver specie monetary system

      • philippe101 says:

        “as persuaded as the Secretary is, that the proper funding of the present debt, will render it a national blessing: Yet he is so far from acceding to the position, in the latitude in which it is sometimes laid down, that “public debts are public benefits,” a position inviting to prodigality, and liable to dangerous abuse,—that he ardently wishes to see it incorporated, as a fundamental maxim, in the system of public credit of the United States, that the creation of debt should always be accompanied with the means of extinguishment [taxation]. This he regards as the true secret for rendering public credit immortal.”

        –in other words public debt can be ‘rolled over’ for ever, so long as there is an adequate system of taxation in place. As such it can serve as a form of ‘immortal’ financial capital.

  7. MRW says:

    It will issue £100 of government debt to a primary bond dealer and receive £100 in cash from him. It will then pay the policeman the £100 which will accrue to his bank account.

    Is that how it is in Britain? It’s the other way around here in the US.

    The government spends first according to congressional appropriations. This becomes a deposit in Treasury’s general account (GA) at the Fed for onward forwarding to the vendor’s and policeman’s bank accounts. Treasury, by law, cannot have a negative balance in its GA, so it then issues treasury securities in the same amount (I’m really oversimplifying here) for auction on the open market. Snapped up ‘day-of’ by the public and foreign governments, investors. This restores the money supply balance. Once a year–as I understand it–Treasury computes the upcoming interest owed on treasury securities and issues more of them to cover that amount.

    This is how Frank N Newman explains it in Freedom from National Debt for the US. And what Warren Mosler means when he says Reserve add before Reserve drain.

    • philippe101 says:

      you’re assuming there is already a positive balance in the Treasury’s account at the Fed when it spends. That might be a reasonable assumption, but initially that balance must have “come from somewhere”. Either 1) the Fed gave the Treasury an overdraft, or bought a bond directly from the Treasury, 2) The Treasury created money and deposited it at the Fed (coins, for example), 3) the Treasury sold bonds to the private/non-government sector, or taxed the private/non-government sector.

      In his book Newman says:

      “I recall from my time at the Treasury Department that the assumption was always that there was money in the fed account to start with. Nobody seemed to know where it came from originally or when; perhaps it was established in biblical times.”

      • philippe101 says:

        Some other options:

        1) The Fed loaned money to the private sector and paid the profit on the loans to the Treasury, 2) The Treasury deposited gold or other assets at the Fed and received a credit to its account in return (this gold/other assets could have been property of the government not acquired through taxation).

      • NeilW says:

        “you’re assuming there is already a positive balance in the Treasury’s account at the Fed when it spends.”

        You’re assuming it hasn’t got an infinite intraday overdraft – which all clearing systems have to have (effectively) or they run into boundary conditions that cause the payment system to start exhibiting failures.

        Plus the Treasury systems run with a positive buffer to stop people complaining.

  8. With you till the end, but this part is wrong,

    “if people are highly confident in the financial markets and there is a fixed amount of money in those markets the velocity of the money in the financial markets can speed up to accommodate any increase in the flow of borrowing.”

    Endogenous money means that the amount of money adjusts to the the level of economic activity. There is no need to bring a nonsense concept like velocity into it.

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