The interest rate fallacy

28 Apr, 2019 at 13:41 | Posted in Economics | 1 Comment

While currency-issuing governments do not need to sell bonds, the fact that they do creates no competition for finite savings between public and private borrowers. First, government deficits stimulate growth and private savings as national income grows … Moreover, deficits place downward pressure on interest rates. Debt issuance serves to allow the central bank to maintain​ a positive target interest rate by providing investors with an interest bearing asset that drain the excess reserves in the banking system resulting from deficit spending. If these reserves were not drained, then in an environment of government deficits, the overnight interest​ rate would fall … and this might compromise the central bank’s target interest rate unless it offers a return on excess reserves, which most do …

The central bank targets the overnight interest rate and can keep that as close to zero as it likes, no matter how large the deficits might reach … The orthodox fears are unfounded​ but persist because mainstream economics does not properly ‘account for’ government deficits and debt because it does not ensure that its models are stock-flow consistent.