13 - Deficits and the National Debt
from Part III - Government Debt
Summary
THE MODELS THAT we have presented up to this point have had a government creating fiat money and taxing or providing transfers to individuals in the economy. Although these are important aspects of government finance in today's world, we have neglected one important factor. Governments frequently finance current deficits by borrowing. In this chapter we analyze the effects of the national debt on government revenue and some effects of monetary policy on the national debt.
High-Denomination Government Debt
We observe in most of today's economies that governments often issue two forms of debt – assets held by the public – one called money (for example, currency) and one called government bonds (for example, Treasury bills). Although they seem equally safe and negotiable, they have different rates of return. The net nominal rate of return on currency is zero, whereas that on Treasury bills held to maturity is positive. Clearly, Treasury bills dominate currency in rate of return. Why would anyone hold currency if an equally safe asset offers a higher rate of return? What difference in the nature of these two assets can explain the observed disparity in rates of return?
One difference in the two assets is the denominations in which they are offered. Currency is issued in small denominations easily usable in exchange, whereas Treasury bills are supplied only in large denominations. Imagine the expression on the face of the checkout clerk if you presented a $10,000 Treasury bill in payment for your $50 grocery bill!
There is a great gap today in the rate of return of currency and that of interestbearing $10,000 Treasury bills.
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- Modeling Monetary Economies , pp. 233 - 254Publisher: Cambridge University PressPrint publication year: 2001