There are two sorts of countries: countries that can print money to pay their sovereign debts; and countries that can't. Canada is a printer; Greece is a non-printer.
Both sorts of countries can get into trouble if they issue too much sovereign debt; but they get into very different types of trouble. Printers get into negative feedback trouble; non-printers get into positive feedback trouble. Positive feedback is always worse than negative feedback, when a bad thing happens. (And positive feedback is always better than negative feedback, when a good thing happens).
Positive feedback is a circular feedback loop that tends to amplify the effects of an initial shock. If the positive feedback gain exceeds one, the second round is bigger than the initial shock, the third round is bigger still, and the total effect gets bigger and bigger until the system explodes. If the positive feedback gain is less than one, the second round is smaller than the initial shock, and the third round is smaller still, and the total effect, while bigger than the original shock, is still finite. The Keynesian multiplier is a positive feedback loop. If the marginal propensity to consume is less than one, the multiplier is greater than one but finite.
Negative feedback is a circular feedback loop that tends to diminish the effects of the initial shock. The second round goes in the opposite direction of the initial shock, and so offsets its effects to a greater or lesser extent. A household thermostat is a negative feedback loop.
Suppose a country issues too much sovereign debt and gets into trouble. Nobody wants to buy any more of its debt, and it has to pay back the existing debt when it comes due.
If the country is a printer, it can print money to pay its debt. If it's in recession, and risks deflation, that's not a problem. Printing money increases demand, which is what you want if you are in a recession. Printing money causes inflation, which is also what you want if you risk deflation. Deflation + inflation = stable prices.
If it prints money and is not in a recession, or has inflation, then that is a problem. Printing money will make inflation worse, and that's a problem. But it's a negative feedback problem. The inflation will lower the real value of the existing debt, making it easier to pay off.
That doesn't mean it's not a problem. The country can't keep borrowing, printing, and inflating forever, because nominal interest rates will rise with expected inflation. There is a limit to how much real revenue you can get by printing money permanently.
You can pay off your debt by printing money, but maybe only once. If lenders expect you to do it again, they won't lend to you. Your reputation suffers, which will make it harder to borrow in future. And you might need to borrow in future. It's not painless.
But if the country in trouble is a non-printer, it's worse. It has to raise taxes or cut government spending to pay the debt. But that tightening of fiscal policy will cause a fall in demand, which may cause a recession and deflation. The recession reduces the country's income and tax revenues, which makes it harder to pay the debt. The deflation increases the real value of the debt, which also makes it harder to pay. So the country will need to raise taxes or cut government spending still further. This is the positive feedback loop. It makes a bad situation worse. If the positive feedback gain exceeds one, the country will have to default, however much it tries. Edward Hugh calls this the debt snowball problem.
Default isn't any better than inflation for your reputation as a borrower.
Debt for a printer is a bit like equity. If things go bad for a country, and it has to print, both the country and the lender share the pain.
Debt for a non-printer is, well, just like debt. If things go bad for the country, it bears all the pain, and then some, because of the positive feedback effects.
Worthwhile Canadian Initiative 
JPKoning: This is great. I’ve got to hit the books, I guess, but at any rate, there’s never a need for primary dealers to buy “unlimited amounts of perpetual zero interest rate debt” in real life, and there seem to be several primary dealers who are quite interested in retaining that privilege. The “refusal” on the part of the FED in 1951 Accord was a bit more complicated than that, but I need to look into it. I remember 1951, but we were thinking about Communists rather than finance in my community, having nothing much to finance.
I think there’s a subtext to this discussion. Makes it fun.
I’ll be baak.
ok, fine. I take mental short cut. What about your own little short cut?…
“If the government’s account at the Fed is empty, and they write a tax refund check to you, when the bank tries to clear the check its going to bounce. Unless the Treasury can quickly top up its account at the Fed in order to settle its checks, it is going to have to declare itself insolvent.”
This will never happen irrespective of your theorising on how leaky the firewall is. The Fed provided the private banking system with tons and tons of liquidity through the purchase of MSB during the crisis, and you are saying it would not do so for the Federal Government? So the Fed did not let private Banks collapse but would be more than willing to let the Federal Government go bankrupt?? That’s sound like a pretty good mental short cut too.
Amyway, don’t take my words on this, take these:
Barney Frank: Do you think there is any realistic prospect of America’s defaulting on its debt in the near future?
Bernanke: Not unless Congress decides not to pay….
Or this one:
RYAN: “Do you believe that personal retirement accounts can help us achieve solvency for the system and make those future retiree benefits more secure?”
GREENSPAN: “Well, I wouldn’t say that the pay-as-you-go benefits are insecure, in the sense that there’s nothing to prevent the federal government from creating as much money as it wants and paying it to
somebody. The question is, how do you set up a system which assures that the real assets are created which those benefits are employed to purchase.”
And how do you create the real assets?
I despise Greenspan and everything he did… I was just quoting him and Bernanke to show that both were working under the assumption that Congress was ultimately in charge of money creation.
I don’t understand anything to what Greenspan said in his second sentence. It might just be typical Greenspan: profoundly intellectually dishonest.
My own little shortcut? Wish I took one, it takes ages to learn the legalities governing various central banks. (the strength of the “firewall” is usually described therein).
Regarding government insolvency, remember my point. A central bank controlled by the Treasury will be TOLD to ensure the government does not go insolvent. An independent central bank will be ASKED to ensure the government does not go insolvent, the choice is the central bank’s to make. There is a difference.
As for quotes regarding solvency, see:
Click to access house_frtd1978.pdf
bottom of pg. 24
Qc: I apologise for taking so long to respond. The point I was making wasn’t that your paradigm was wrong, but that it is the same as Nick’s. His story goes:
1: Issue bonds and Spend
2: Print money to buy bonds
Yours is:
1: Print money and spend
2: Issue bonds to hit monetary target
Given that policy is a flow over time, not a discrete one time event, they are the same in theory. I believe that your story is how policy is actually done, but if it were switched, nothing substantial would change.
Premierement without restraint leads to inflation. Bonds never need to be issued, but exchanging currency for bonds is deflationary, so it helps the central bank to hit their target to do so.
Deuxiement affects the opportunity cost of holding currency exactly the same way that issuing bonds does and so has similar effects. If the interest on reserves is higher than the interest rate on bonds, bonds become irrelevant for monetary policy.
Lastly, a good economist does not forecast. A good economist interprets market forecasts. Since the market is not forecasting high inflation, I don’t expect it. If I disagree, it is more likely I am wrong than the market is wrong. I have no idea what’s going on in Japan, but I don’t claim to.
Jp Koning:
Are you not proving my point…? The exchange in the link you provided took place in the context of the debate on debt ceiling, which was imposed by CONGRESS. If the Fed would allow the Treasury to go on margin (which is obviously debt for the Treasury!), this would go against the political decision made by elected officials in Congress. Maintaining debt ceiling when deficit is increasing amount to a political decision to default. This is precisely my point: US can not default unless there is political decision to do so. This goes to show you that the Fed would do whatever they are told by elected officials (if this needs change in legislations, so be it).
In any case, and I am don’t think I will convince you, the Fed will never bankrupt its own Government. That much is certain. There will always be a way to go around the legalities you have so scrupulously surveyed (I commend you for that). This could be generalised to all countries with their own floating currency in the OECD.
BTW- If you are interested in the relationship between Government and the Central Bank, the following link gives you some background as to why monetary authority in Canada ultimately rest with the Minister of Finance:
http://www.time.com/time/magazine/article/0,9171,894502,00.html