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  1. #1

    Default What happens when a central bank buys government bonds?

    When a central bank buys some government bonds, do the bonds just get thrown away as if they had never existed? Or are they somehow still active - i.e. is the government still obliged to pay the coupon and eventually the principal on them?

    So for example I can see one of two scenarios being true:

    Scenario A:
    The government create 10billion of bonds and sells them to
    the private sector.
    The government debt is now 10 billion.
    Then the fed creates 10 billion of fresh new money to buy back the bonds.
    The bonds are destroyed and forgotten about.
    The government debt is now zero.

    Scenario B:
    The government create 10billion of bonds and sells them to
    the private sector.
    The government debt is now 10 billion.
    Then the fed creates 10 billion of fresh new money to buy back the bonds.
    The bonds are retained and are still "active".
    The government debt is still 10billion - but the debt is to its central
    bank. (rather like your left hand owing your right hand money!)

    Which one is the case (or do we need a scenario C?).

    P.S. The last step in scenario B may not be so silly after all. It is effectively a commitment being made to the outside world that 10billion of base money will be destroyed at some future time thereby giving people confidence in the value of the currency - or other/subsequent government bonds.
    Last edited by Mickanomincs; 10-03-2011 at 12:42 AM.

  2. #2
    Senior Member
    Join Date
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    Location
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    Default

    Scenario B, with the caveat that your right hand has to cover its operating expenses and skim 0.5% for its semi-private owners.

    Under the Board's policy, the Reserve Banks are required to transfer their net income to the U.S. Treasury after providing for the payment of statutory dividends to member banks and equating surplus to paid-in capital.
    FRB: Press Release--Reserve Bank income and expense data and transfers to the Treasury for 2009--January 12, 2010

  3. #3
    Senior Member
    Join Date
    Feb 2010
    Location
    Melbourne, Aust
    Posts
    305

    Default

    Then the fed creates 10 billion of fresh new money to buy back the bonds.
    The FED doesn't create any money, instead money it is invested in the FED by its member banks and the government.

    If the FED buys hundreds of billions worth of bonds, then the money has mainly come from its member banks.

    The money printer is the US treasury, which deposits newly printed money or other revenue at the FED. The FED pays the government interest for this "deposit".

    If the FED is buying a lot of T-bonds it means its member banks have ran out of eligible people to lend to.
    I reach for the Moon! But whoops I crashed London and NY? - Milton Friedman.

 

 

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