(I had been planning to write this post before Steven Landsburg started a whole blogosphere argument about what taxes are for. Honest!)
Functional Finance says you only use taxes if you want to reduce Aggregate Demand to prevent inflation. The Long Run Government Budget Constraint says you use taxes to pay for past, present or future government spending. They sound very different. They aren't.
There's a general principle in economics: first you eat the free lunches; then you look at the hard trade-offs. Functional Finance says "first eat the free lunches". The Long Run Government Budget Constraint says "then look at the hard trade-offs".
Suppose, just suppose, that if you kept on doing what you were planning to do, you never had to worry about inflation. Not now, not in the future, not ever. Because Aggregate Demand was too low now, and was projected to be too low forever. So you are not worried about inflation. Instead you are worried about deflation. And you were a government that could print your own money. What would you do?
You would print money and spend it. Or print money and use it to finance tax cuts. And you would keep on doing it, more and more, until you got to the point where you did start to worry about inflation. You first eat all the free lunches.
That's the underlying kernel of truth in Abba Lerner's Functional Finance (pdf) [see also his book The Economics of Control (pdf)]. And I don't know of any mainstream macroeconomist who would disagree. You use taxes only so you don't have to print money. When you get to the point that Aggregate Demand is high enough, so you start to worry about inflation, you use taxes to finance past, present, or future government expenditure precisely because you don't want to print more money and make inflation higher.
Suppose inflation isn't a problem right now, because Aggregate Demand is currently too low. Does that mean the government should print money and spend it? Not necessarily. Print money yes, but instead of spending it on goods, or on tax cuts, it might be better to use it to buy back some interest-paying government bonds. Because even though inflation isn't a problem right now, it may be a problem some time in the future. So you can buy the money back in future, by re-issuing the bonds (and save on interest in the meantime) without having to raise future taxes or cut future spending.
Here's an easier way to think about it. Print enough money to get Aggregate Demand and inflation where you want it to be. That's the free lunch the government can eat. Any additional government spending must be paid for, sooner or later, with taxes. The present value of taxes, plus the present value of newly-printed money (seigniorage), equals the present value of government spending, plus the existing debt.
Seigniorage revenue belongs in the government budget constraint. The government can pay for part of its spending by printing money. But don't get too excited. It's not that big, on average. If central bank currency is around 5% of annual nominal income, and if nominal income is growing at 5% per year (3% real plus 2% inflation) then 5% x 5% = 0.25% of GDP. (In the right ballpark for Canada — it shows up as the profits the Bank of Canada hands over to the government — but maybe double it for the US). Printing money is a nice little sideline, but we are still going to need taxes.
Let's ask a slightly different question. Why do governments pay interest on their debt? Actually, it sounds like a different question, but it's really the same question. Why finance government deficits with interest-paying debt, when you could use non-interest-paying currency?
The answer is the same: you pay interest on the debt to encourage people to hold it and stop people spending it. If you cut the interest rate on government debt, will people sell it back to the government for money, spend the money, and cause inflation? If not, then Aggregate Demand is too low, and the problem is deflation, not inflation. So there's a free lunch from cutting the interest rate on government debt. And the government should eat that free lunch. And then the Long Run Government Budget Constraint kicks in again.
Now suppose the real rate of interest on government debt is below the real growth rate of the economy. (Or the nominal rate of interest is below the growth rate of nominal GDP — same thing). And suppose it will be like that forever, if you keep on doing what you were planning to do. The government can run a Ponzi scheme forever. It can borrow and spend, then borrow to pay the interest forever, and the debt grows more slowly than the economy, and the debt/GDP ratio declines over time. The Long Run Government Budget Constraint is undefined. The Present Value of taxes can be less than the Present Value of Government spending.
That's another free lunch that needs eating. The economy is dynamically inefficient. The economy wants a Ponzi scheme. And the government should satisfy that demand. Issue debt until the interest rate equals the growth rate. Then the Long Run Government Budget Constraint kicks in again.
Worthwhile Canadian Initiative 
A further comment on Nick’s point that productive Government investment may crowd out private investment. Surely the functional finance position was that Governments should undertake such investment when AD was deficient (since otherwise the zero-inflation objective rules out deficit finance). As an old Keynesian, I don’t believe we should worry about crowding out in these circumstances.
William: I used to be an Old Keynesian too, when I was young. And I still am a bit Old Keynesian, some days. So let me offer an internal critique:
One of the things we Old Keynesians weren’t very good at was thinking about what exactly it is the government spends on, and whether this could matter for AD. We just wrote down AE=C+I+G, added a consumption function and an investment function, and treated all three components as separate. G did not appear as an argument in either the consumption function or the investment function. And if we think about it, that only really makes sense if government expenditure is on something totally useless like pyramids. We added G to GDP, and then ignored it. G did not appear in the utility function affecting the marginal utility of either present or future consumption; and neither did it affect the Marginal Efficiency of private Investment.
The government builds a bridge. Is it the “bridge to nowhere”? Would private firms have built it anyway? Or does it create an opportunity for profitable private investment now they can get the goods to market over the bridge? Is it a substitute or a complement to private investment? Is it also a substitute or a complement for current consumption or current saving? (Does it mean the old folks can walk to the Bingo over the bridge, so we don’t need to save as much for taxis when we are old? Crap example, I know).
We ducked all those questions. But it’s hard to duck them when we start thinking about the future revenue stream from government investments. They matter not just for welfare when the economy is at “full employment”; but they matter for AD too. The fiscal multiplier depends on what the government buys. It could be zero, negative, or it could be much bigger than the Old Keynesians thought, even if you accept all the Old Keynesian assumptions about the LM and AS curves. What the government spends the $100 on will affect how much the IS shifts (and might even cause it to shift the wrong way).
That was what I was getting at above, on productive investment.
JW: I don’t follow all your comment. Let me respond to the bits I think I understand, then try a shot-in-the-dark.
“First of all, can we agree that the Long-Run Budget Constraint, as defined here, has zero content for policy? It’s descriptive, not prescriptive. It says that a shift toward deficit in this period necessarily implies a future-period shift toward surplus of equal PV, but it says nothing about whether such a shift is desirable.”
Like all budget constraints, it is necessary but not sufficient for getting policy right. It can tell you we have to cut G or increase T sometime, but not when. You need to supplement it with something else, for example an argument for smoothing T and/or G over time.
Looking at the current US fiscal position, the LRGBC, plus forecasts, say that there will have to be some nasty cuts in G and/or nasty increases in T sometime in the future. If something big and nasty is going to happen, most people call that an impending crisis. (Though it does remind me of what a former Canadian Prime Minister, Jean Chretien said once: “Sure I am driving towards the cliff. But the cliff is still a kilometre away. So when I get there I will turn the steering wheel. That’s not a crisis!”)
“It shouldn’t be government debt on the left side, but total government liabilities and assets.”
Sure. Put “net debt” on the left hand side, provided the assets are valued at the present value of the income they earn. Or add revenue from government investments to the tax revenue on the right hand side.
“The important thing about this is it raises the question, how do we know the government is actually on its LRBC? note that strictly speaking, the constraint is an inequality.”
Interesting. I would say that it holds as an equality. Just as the debt/GDP ratio can’t go to plus infinity in the limit (because the young generation wouldn’t be able or willing to buy all the bonds off the old generation), it can’t go to minus infinity either (because the government would just run out of assets to buy, after it had nationalised everything, including all human capital).
“But my main argument is that there is a logical inconsistency in your position. Question: Are deviations in aggregate income due to fiscal policy strictly temporary, or do they have a permanent component? In the first case, if in the long run output always converges to potential, and potential output is unaffected by current output, then all fiscal policy can do is shift income between periods.”
Temporary. (Actually, not even that, if monetary policy can and will be used as a substitute for fiscal policy, but let’s leave that aside). I see where you are coming from with “…then all fiscal policy can do is shift income between periods.” But if you just slightly re-write it, so it says “…then all fiscal policy can do is shift aggregate demand between periods.”, that is precisely what we want it to do. We want to boost demand during a recession, to prevent income falling, and reduce demand during booms, to prevent inflation rising. That’s classic countercyclical stabilisation policy.
“But”, I think I hear you say, “what if Aggregate Demand is permanently depressed, so we are in a permanent recession? In that case, don’t we need a permanent deficit, that might be large enough to violate your precious LRGBC?”
That’s the Keynesian nightmare scenario — secular stagnation.
Let me give two answers:
1. that’s what monetary policy is supposed to handle. There’s no limit to printing money, permanently (except inflation of course, but if you are worried about secular stagnation and deflation then a bit of inflationary pressure is just what’s needed).
2. What about Japan? Well, if you can push r down to zero, into the stable Ponzi area, it’s fine to run deficits. And it’s only when the public is unwilling to hold the debt, and wants to spend it, that you have to raise r above zero to stop them spending it and causing inflation. But by then you are out of the secular stagnation anyway. [There is the “Ketchup problem”, but let’s leave that aside].
This is where you lost me: “To go back to the example of whether finding some overlooked debt should cause us to run a lower deficit in the current period — in a LRBC world the answer is No, because that additional stock of debt also tells us that future demand growth is stronger than we expected, and so future tax revenue will be higher.”
Let me try a shot-in-the-dark:
Our thought-experiment. Suppose we have the economy exactly where we want it. AD just right, and expected to stay just right in future, given our planned time-paths for G, T, and M. And those paths also satisfy (we think) the LRGBC. Then we discover an extra $100 debt hidden away. So I say we have to cut G and/or raise T. And you reply (I think) “But that will cause a recession!” And I respond by saying you may well be right. Let’s assume you are right. So we need to increase M/cut r to offset the reduction in AD from cuts in G and/or increases in T. But those increases in M/cuts in r amount to a free lunch for the government. True, and the government should eat that free lunch. So, taking the offsetting monetary policy into account, the LRGBC says we don’t need to cut G and/or raise T quite as much as we first thought we did.
JW: to sum up, if you assume the IS curve is vertical, so monetary policy is unable to affect AD, then I can make sense of everything you say. But I don’t believe that. Most economists don’t.
Nick,
You said
“One of the things we Old Keynesians weren’t very good at was thinking about what exactly it is the government spends on”
Actually, how government spends is not much different than how a corporation spends. Decisions to spend have to be justified. Let us take the case of a VC investing in a small startup seeking $1 to $2 million in seed funding and a small SBIR grant given say by the US Government, say the Department of Defense, or the National Institute of Health.
At the VC Fund, a fresh MBA will look at the proposals, and finally will decide whether or not to invest — in his view, considering the likelihood of success at producing a return for the limited partners. But that person will ultimately be promoted based on his success/failure rate.
The other side also employs professional decision makers. They will evaluate the proposals also for how likely they are to be successful. The criteria of success will be different, but it is never the less there. The proposal will be whetted by industry and academic professionals for the soundness of the science. Then, the risks are further lessened by giving a small amount first (say $250,000) and then on the successful completion of that first stage, a larger sum may well be given (upto $2M) — the competition for such grants can be fierce.
So, are the SBIR grants crowding out the VC’s? I would contend that they are not. They are much more likely to be complementary in nature. There is a further need of such programs in recessionary times. In boom times (e.g. the dot com boom), even the most stupid ideas got VC funding. In the current GFC, there is very little VC funding to be had – so great start ups are dying on the vine — So where is the money to fund such entrepreneurial activities going to come from? McDonalds just hired 62,000 low wage workers from over 1,000,000 applicants. So is it that over 940,000 applicants were total losers? Do you mean to say that the Government cannot come up with reasonably productive jobs for these people to do?
An ELR/JG program (Employer of Last Resort/Job Guarantee) has to be there. One way for the program to work is to give ABOVE minimum wage for half time work — that way, the worker can work at a minimum wage job, or look for higher paying jobs. The private sector will not be denied minimum wage workers, but they will only be able to hire them for less than full time work. A program like this would give dignity to the least among us!
Also as an addendum to the above post, in the 1930’s,WPA hourly wages were typically set to the prevailing (median) wages in each area.[8] However workers could not be paid more than 30 hours a week.
Also, the 8 should have been a * — the reference being – Bradford A. Lee, “The New Deal Reconsidered,” The Wilson Quarterly 6 (1982)
Another good book is – “The Works Progress Administration in New York City”
By John David Millett 1978 http://books.google.com/books?id=b0_IowoZsw8C&pg=PP7#v=onepage&q&f=false
Another good article by Edwin Amenta, Ellen Benoit, Chris Bonastia, Nancy K. Cauthen and Drew Halfmann of NYU – “Bring Back the WPA: Work, Relief, and the Origins of American Social Policy in Welfare Reform” http://www.socsci.uci.edu/~ea3/Bring%20Back%20the%20WPA%20Studies%20in%20American%20Political%20Development%201998.pdf
Sorry for the disjointedness of my references
One of the things we Old Keynesians weren’t very good at was thinking about what exactly it is the government spends on, and whether this could matter for AD.
If you’ll pardon a hack like myself going through your two, thoroughly realistic :-), scenarios:
Gvt. builds pyramids by deficit spending, which in turn has 0 positive effect on future AD. The money that seeps into the economy via the pyramid building contractor in the same way that it always has and always will. The effect of the deficit peters out with savings. And thus, at some point B in the future, there will be a need for further deficits to keep the current inefficient economy running at full employment (unless people suddenly decide to dissave). We have something akin to secular stagnation (as has been the case in most western countries for at least the past 30 years). So, given some minor inflation, the government budget deficit will actually have to continually rise to keep AD on track.
In the second case, in which govt. builds the bridge that gets seniors to their bingo, the deficits lead to a booming future bingo paradise (aka hell), and the necessary path of government spending will be very different. Since, through its sly investment, AD begins to steadily rise, future deficits will have to be continuously smaller and maybe even have to become surpluses if bingo-ing gets totally out of hand. In this case, the initial deficit does have some sort of a budget constraint attached to it.
Current discourse, both professional and general, seems to invoke the inevitability of the first case in a moral way, when it calls for spending cuts, while simultaneously using the very optimisitc assumptions of the second case when ‘substantiating’ the arguments with hig-flying talk of budget constraints and such. MMT posits that reality is somewhat closer to the first case, not least because of savings desires. It also posits that the way to get closer to case 2 is by keeping people employed at all times. The aim is definitely Nr.2 , but Nr.1 is better than nothing at all.
In any case, given that markets and politicians behave the way they do, there is not one ‘optimal’ government spending path, but, taking these two scenarios as poles of a continuous line, in fact there are at least two, very different ones. They are both functional in terms of keeping employment full and AD below full-blown inflation, but only one is efficient. It is called functional finance, not efficient finance after all… This, in turn, is also one of the reasons that FF prefers fiscal over monetary policy. With fiscal policy it is, at least theoretically, possible to positively influence future AD by making smart investments and also to address inequalities (that feed into market inefficiencies) by targeting spending. Targeting with monetary policy is somewhat more difficult if one doesn’t have a lot of blind faith in markets. The other argument is that reliance on monetary policy requires much higher levels of private sector indebtedness to achieve the same results, notwithstanding the fact that results would not be the same, but that’s another discussion, I guess…. At permanently low nominal interest rates such private indebtedness is not a problem. But with varying interest rates (i.e. monetary policy) and with interdependencies of modern markets, this breeds instability and uncertainty. Also, monetary policy not only weeds out malinvestment (as it should), but, among other things, incentivises capital holders to seek higher interest rates to extract rents and thus disincentivises productive work (as it shouldn’t). So there is a case to be made for looking for ways to have one but not the other.
Hope that makes sense.
Nick – on pyramids etc
I fully agree. My point was that the two types of spending (pyramids and useful bridges, or useful and useless public goods) have different implications for the future time path of tax rates. If you allow the government to invest in private goods (toll roads and hydro dams – in the 30s Governments hadn’t privatised all of these) then there is a third type of spending, since these investments will be partly or wholly financed from future commercial revenue.
Oliver
As I understand the monetarist orthodoxy, a major objection to fiscal policy is that the market always makes smarter decisions than the Government. If you care about distribution (and I’m not sure many of them are that bothered) then your redistribution policy should be based on simple cash transfer mechanisms (progressive taxes and tax credits) which are not varied in response to macro shocks. There are aspects of this with which I have some sympathy (eg don’t build ‘bridges to nowhere’).
don’t build ‘bridges to nowhere
absolutely. but identifying the quality of those ‘bridges’ is what the discussion should be about, not about deficits per se. and i believe that is the point that MMTers are trying to get across.
William Peterson said:
As I understand the monetarist orthodoxy, a major objection to fiscal policy is that the market always makes smarter decisions than the Government.
I think what is missed is that the market works for short term planning, and rarely works for medium and long term issues. Within corporations, planning may get done for the medium term (1-2 years) but rarely has a time horizon beyond that. Then there is the issue of long term risky investments — which will never be undertaken by private capital, and can only be undertaken by the Government. That was the point of one of my examples above.
The second example above dealt with the responsibility of the Government, which is to maintain minimum standards of life, labor and dignity, and to make sure that the powerful cannot prey on the weak. This last is something that the market is quite antithetical to. There are some very good theoretical papers which show that in purely competitive markets, with the ability to extract wealth based rent, the wealth gets increasingly concentrated in the hands of the top 1% or so of the population with the passage of time.
“Looking at the current US fiscal position, the LRGBC, plus forecasts, say that there will have to be some nasty cuts in G and/or nasty increases in T sometime in the future. If something big and nasty is going to happen, most people call that an impending crisis.”
It’s only nasty if it’s pro-cyclical. Cutting G and raising T in a boom is painless. Why do you want to smooth them?
Max: “Cutting G and raising T in a boom is painless.”
Not to the people who want the benefits from the government expenditure, and who pay the taxes.
“Why do you want to smooth them?” standard micro reasons: diminishing marginal benefits from government spending, and increasing marginal deadweight costs of distorting taxes.
Max: “Cutting G and raising T in a boom is painless.”
Nick Rowe: “Not to the people who want the benefits from the government expenditure, and who pay the taxes.”
Mebbe so, but the pain of a surplus or balanced budget is much less during boom times. Despite that fact, for some reason legislators are more inclined towards such measures during hard times. IMO, legislation should make it as automatic as possible. We already do that with gov’t spending, by mandating additional spending in hard times. We could do it with taxes, by having high marginal rates, but with automatic rebates outside of boom times.
Min says:
for some reason legislators are more inclined towards such measures during hard times
This comes from thinking that Government financing is similar to household and business financing. Think of former businessmen running for state and federal office -“I shall run the government as a business” Indeed if you are a household or a business, it is much easier to envision going into debt and to think that you shall have the ability to pay back the loan with interest during boom times, and lean times are times for budgetary contraction. Same thinking is quite valid for businesses as well.
What these people forget, is that the Government is the supplier of money, while the private sector is the user of money. This is one of the key tenets of MMT/Functional Finance. Government is the endogenous producer of money, and therefore theoretically has no budget constraints. The only constraint being inflation (which will happen only if the economy is at full resource utilization) – Thus counter cyclical finance is very alien to legislators and to the common person. This is one lesson that is NOT taught in colleges and universities — having been through over ten years of business and economic curriculum at the graduate school level, I can assure you that this fundamental difference between government and household finance is not highlighted in the curriculum! If it is not a part and parcel of business school, and the economics department, then it is definitely not a part of Law School. A majority of legislators are lawyers.
So yes what you sau is indeed true, and is the cause of many of our troubles!
“If the spread between MZM Own Rate and FF is 2%, then 7 Trillion * 2% = 140 Billion per year.”
OK, that’s 1% of GDP in seigniorage profits. But let’s talk about the REAL money. If Tsy applied the RSJ tax (or the Fed applied the remarkably similar RSJ user fee) to the Fed fund market, wouldn’t that peg the Fed Fund rate as effectively as paying interest on excess reserves? If the lending bank must build in the cost of, say, a 2% tax (annualized) on overnight loans, its a safe bet the Fed Fund rate isn’t dropping below 2%. Whenever Tsy (or the Fed) wishes to raise or lower interest rates, it’d simply adjust the RSJ tax, increasing or decreasing both Fed Fund rate and tax revenue in one fell swoop.
A tenet of MMT is of course, that the purpose of Tsy selling bonds (or the Fed paying interest on reserves) is interest rate maintenance, that is, if the govt didn’t drain excess reserves, the Fed Fund rate would drop to zero. An RSJ tax that anchored the FFR would allow the govt to spend without borrowing (most straightforward way, if Congress authorized Tsy to electronically create US Notes– Lincoln’s Greenbacks– whenever it needed to write a check). That means the present cost, 2% or 3% of GDP, of net interest on the debt would go away. Indeed the more excess reserves created, the bigger the tax base for RSJ’s handy tax. Let me know if I missed something in that happy tale.
One final note about interest rates, remember SRW’s point that while the prime rate markup has been locked at 3%, it used to vary and averaged less than 1.5%. The Fed could always order banks to increase or even decrease (ha!) the 3% prime rate markup.
http://www.interfluidity.com/posts/1160447599.shtml
I’ve added another graph to better illustrate the regime change in Canadian deposit rates. The second graph plots overnight savings rates and overnight savings over $100K versus the policy bank rate. I think it shows pretty clearly that deposit rates, since they hit zero, have become disconnected from the policy rate.
I know its very late in the conversation so I’m just going to summarize my main points:
1) Canadian deposit rates used to be 1-2% below the policy rate, and would follow that rate quite closely. The spread increased dramatically over the years, and furthermore deposit rates have ceased to follow the policy rate, and instead are stuck at zero even when the policy rate has risen as high as 8%.
2) There is no excuse for this in terms of marginal cost: technology and automation have increased dramatically and there are no new services associated with deposit accounts. If deposits could pay Bank Rate minus 1 or 2% in the 80s, they could pay more now. The only reasonable explanation for the current situation is the existence of a suboptimal equilibrium, i.e. a market failure as described in my comment above.
3) When there is strong empirical evidence of a large market failure, that is good cause for government to step in. The federal government should create a system of digital cash that pays the policy rate and charges transaction fees (like LVTS but for all Canadians). To complete the transition to a free market banking system, they should set a timeline for revoking deposit insurance. Investors in bank debt and other securities should be able to monetize their assets via repo at the bank of Canada, which would enable more than adequate money creation.
Forgot to add: The deposit rate dynamic described above is just the $200bn of overnight savings deposits. The government system would also provide an alternative for the $460bn of chequing deposits (currently earning nothing) and $570bn of term deposits that are also guaranteed by the citizens of Canada.
Finally, here is why I don’t like RSJ’s tax (though I like it better than the current system): It only further entangles government and banks, it further entrenches a fundamentally unstable system of money creation, and does nothing to enforce a market price for deposit insurance. Once there is a safe alternative system of money, we can be free of the moral hazard of deposit insurance and resulting public bank bailouts, and the banks can be free to intermediate credit, without burdensome regulation or other state interference. It’s win-win.
beowulf: I don’t understand. You can tax demand deposits at FF because they don’t pay interest to the holder. But if you tax interest paying deposits (in an efficient competitive equilibrium), the interest will have to drop by the amount of the tax, i.e. the tax incidence will be on the depositor. If you tax the FF market, though, banks aren’t going to use it. They’ll find some untaxed way to lend: TRS, off-market trades, God knows what. Anyways, the interbank market is a good thing. It transfers balances between banks as required by the current system of payments. It’s not some kind of vast source of monopoly profit (unlike demand deposits), so taxing it will only create market distortion. Perhaps I don’t understand your proposal. If so, maybe you can make it clearer.
K,
There is no “market price” for deposit insurance. And no, guessing does not give you an efficient price.
Deposit insurance is required in any modern economy. We would have a much more unstable economy without it.
… which is another way of saying that the efficiency results fail to apply when people either are unsure of the utility that they will receive from a good (or claim), or when there is any disagreement about the probability of an event occurring.
Yes, you will still have a market price, but it wont be an ex-post efficient price, it will be an inefficient price.
In that case, it may be better for the government to provide the service at cost outside of the market allocation system. The welfare theorems only result in efficient outcomes when you know what you are buying or when there is perfect unanimity about the likelihood of events occurring.
That is why I am not a free-marketeer. If you let security markets price everything, then you will be in a horribly inefficient world.
“Deposit insurance is required in any modern economy.”
That seems unlikely, given that formal insurance is limited in scope – only covering small bank deposits and completely ignoring the massive non-bank deposits held in money market funds.
Here is my layman attempt to summarize MMT/Functional Finance:
Govt deficit should be accommodating the non-govt sector’s desire to save currency + the growth of the economy. Any part of the govt spending that is not saved or does not result in growth (and thus does not pay for itself) has to be taxed away or inflation will occur.
Now, this is all good in “normal” regime. But…
if saving propensities change so abruptly that a regular fiscal adjustment is impossible, then price controls and rationing JK Galbraith style are in order.
The last bit refers to abnormal circumstances that can result from external shocks (natural disasters, wars, massive brain farts of the populace…)
@Nick Rowe:
This is what I find baffling about mainstream economics (not having any training in economics) – this idea that the govt needs to bribe the non-govt sector not to spend via the interest rates on the bonds. The way I see it, there is never a person who says: the interest rates are too low, let me go and buy a canoe instead (using your own example from the Winterspeak thread 🙂 ) The households decide what part of their income to save first and on the vehicle of savings later. Even more true for pension funds, that have funds they have to save. If there are no govt bonds, they’ll have to channel their savings into some other vehicle, depending on their risk aversion (so, those that invest in govt bonds would most probably switch to the next available low risk low return investment like munis.) This money that is not used to buy the govt bonds starts running around the available savings/investment vehicles, lowering their rates/raising their prices to the new indifference level.