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Does increasing government deficit put downward or upward pressure on interest rates?

Mmt suggest government deficits put downward pressure on interest rates because of an increase in reserves.

But the government also try and match bond issuance with deficit spending. I thought the issuance of bonds will put upward pressure on interest rates because if you keep selling bonds, there will be more bonds on the market pushing bond prices down and yeilds up?

Or is the interest rate that central banks set totally separate from bond yields?

Hi @jon,

This is one of those concepts in MMT that they're a little sloppy about. The MMT people often treat bonds and reserves as if they're the same basic thing. And they're most definitely not. Reserves only exist because we have private banks and not a fully state money system. This is super important to understand and contradicts many elements of the State Theory of Money.

For example, they argue that deficits create reserves. This isn't quite right. Monetary Policy creates reserves and deficits result in additions to the Tsy's TGA account which are then transferred to a bank when the govt spends. The flow of reserve funds starts with the Fed, not the Tsy.

Of course, the Fed system is a closed system so more reserves result in downward pressure WITHIN the reserve system. This isn't true of the broader Tsy Bond system, which is very much an open system. So they're conflating two different concepts here by treating reserves and bonds as if they're the same basic thing.

In short, there's no reason why interest rates on US govt bonds couldn't be very very high as the supply increases. Then again, inflation is much more complex than just "more money chasing fewer goods" so we need to be careful assuming that more bonds will equal higher rates.

"Pragmatic Capitalism is the best website on the Internet. Just trust me. Please?" - Cullen Roche

Hello @cullen-roche,

What determines the bond yeilds, is it investor sentiment? If they decided to deem government bonds risky would yield go very high?Could the central bank step in and buy alot of bonds to keep yeilds low, like how they have been doing currently with QE? Who decides the bond yeilds, is it market or is it government?

Does mmt state that money comes from government because reserves are created when they spend out of there treasury tga account and reserves disappear when money goes into the tga account? If the TGA is just an account at the central bank why does the reserve disappear when money goes into it?


Kind regards,



Hi @jon,

MMT says that taxes destroy money because they're consolidating the Fed into the Tsy. So, when a bank clears a payment to the Tsy via the TGA they do so by sending a reserve deposit to the TGA. This technically removes a reserve from the interbank system (essentially destroying it) and sending a govt asset to itself (which technically destroys it in the same way that a bank destroys a deposit when you repay a loan).

This is pretty misleading though because the whole point of taxing a deposit is to spend a deposit and the deposits aren't govt liabilities, they're bank liabilities. We specifically have reserves (and a TGA) because the financial system is built predominantly around banks. Consolidating the Fed into the Tsy treats the reserve system like it doesn't even exist. Worse, it misconstrues the fact that private banks are the center of the financial system.

If you're going to consolidate the Fed into the Tsy it's more reflective of reality if you do so by consolidating them into one entity and then consolidating the entire banking system into one bank. This creates a clear depiction of the existing system where there is just one private bank that services the consolidated Fed/Tsy. In this system it becomes clear that the govt is mostly redistributing that bank's deposits and creating net new assets when they run a deficit (just like any borrower from a bank).

It also becomes clear that interest rates are a complex relationship of money demand/supply. If the demand for money falls there will be a rise in the price level (inflation). The govt might have to fund itself at a higher interest rate to create more demand for money. So it's cleaner to think of the govt as funding itself at the cost of inflation whereas the rest of us fund ourselves at the cost of inflation PLUS the cost of our credit. The govt has no credit risk because they're the most credible entity in the economy by virtue of their taxing authority. But their money still has a cost and that cost is reflected in the rate of inflation.

I hope that helps clarify.

"Pragmatic Capitalism is the best website on the Internet. Just trust me. Please?" - Cullen Roche

Hello @cullen-roche,

I understand that when a bank loan is repaid, money is destroyed as it's no longer on the banks books or the borrower's. However I don't understand how money is destroyed when taxes go to the tga. Isn't there a reduction in a private individual account when they pay tax and an increase in the tga account of the same amount? If it's just gone from one account to another account why is this considered being destroyed when tax received can be seen on tga account?

If I understand you correctly the main influence on interest rates is inflation. The treasury and fed can control interest rates but they are a response to inflation?

Hi @jon,

The way you're describing it is correct. Nothing is actually destroyed under the actual institutional structures in place today. MMT intentionally misconstrues this by consolidating the Fed into the Tsy. So, if you consolidate the Fed into the Tsy then the govt is obtaining its own liability when the TGA obtains a settlement balance. That would functionally destroy the money and the new spending from TGA would create it.

Of course, once you understand the purpose of the reserve system (to help smoothly redistribute BANK DEPOSITS) then you understand that the consolidation narrative is nonsense and misconstrues the way things actually are. There is no creation and destruction of money when settlement balances are sent to TGA. There is only redistribution of deposits via settlement balance transfers. Kelton actually got this right in a 1998 paper she wrote so she clearly understands this and still intentionally misconstrues the narrative for some odd reason:

if the government ran a balanced budget with daily tax receipts and government spending timed to offset one another, there would be no effect on bank reserves.”  

The kicker is that it makes no sense to consolidate the Fed into the Tsy because the whole reason we have a Fed is because we have a competitive private banking system. If you consolidate the Fed away then the only thing that makes sense is to treat the banking system like it's nationalized (or monopolized as one bank) or entirely private, which would mean that the banks settle payments using private liabilities, not Fed reserves. None of this makes sense when you understand the actual design of the system and I have no idea why smart people like Warren Mosler would even promote such an obviously flawed narrative.

Of course, under the current structure it is accurate to say that govt deficits create new money (or new bonds). But taxes and spending in and of themselves do not necessarily create nor destroy anything.

This is THE central misunderstanding promoted by MMT people (though there are many many others). But once you get this one you can begin to see that they torture and twist the reality of today's system to promote a series of narratives that are loosely right at best.

Regarding interest rates - bingo. Inflation is the dog. The Fed (and govt) is just holding the leash and trying to keep the dog under control.

"Pragmatic Capitalism is the best website on the Internet. Just trust me. Please?" - Cullen Roche

Thanks @cullen-roche for detailed explanation.