Can Taxes and Bonds Finance Government Spending? pdf

Can Taxes and Bonds Finance Government Spending?

by

Stephanie Bell*

Working Paper No. 244

July 1998

*Cambridge University Visiting Scholar, The Jerome Levy Economics Institute

The author wishes to thank Peter Ho, John Henry, Edward Nell, and Randy Wray for helpful comments.

Remaining errors are mine.

Abstract

This paper investigates the commonly held belief that government

spending is normally financed through a combination of taxes and

bond sales. The argument is a technical one and requires a detailed

analysis of reserve accounting at the central bank. After carefully

considering the complexities of reserve accounting, it is argued that

the proceeds from taxation and bond sales are technically incapable

of financing government spending and that modern governments

actually finance all of their spending through the direct creation of

high-powered money. The analysis carries significant implications for

fiscal as well as monetary policy.