Saturday, December 26, 2009

Maturity Diversification

In an earlier post I linked to a provocative proposal by Andy Harless in which he argues that the Treasury should be shortening the maturity structure of government debt. His reasoning is roughly as follows:
  1. At current interest rates, money and bills are virtually identical assets: holders of bills are requiring no compensation for the additional liquidity or safety that money would provide. This makes conventional monetary policy (exchanging cash for bills) ineffective. On the other hand, an increase in the issue of bills can have expansionary effects, putting the Treasury effectively in charge of monetary policy.
  2. In addition to its expansionary effects, a shift to shorter maturities on government debt should lower the expected value of the costs of debt service, since there is a liquidity premium to be paid on longer term bonds. However, it would also increase the vulnerability of the Treasury to unexpected increases in short term rates (expected increases are already implicit in the yield curve). 
  3. Maintaining long maturities to insure against this risk would be hedging against good news, assuming that an unexpected increase in short term rates would signal a more rapid recovery than is currently forecast. In this case (unexpectedly) higher rates would be accompanied by (unexpectedly) greater federal revenues and lower benefit payments, so the financial position of the Treasury need not be worsened despite the greater costs of debt service.
That's his argument, if I understand it correctly.  The proposal is similar in some respects to one made recently by Joe Gagnon, in which he argues that the Fed should be buying substantial amounts of long term debt. Both proposals would result in roughly the same mix of short and long term securities in the hands of the public, and would lower long term interest rates. But there are two important differences. First, as Gagnon notes, "it would be better for the Fed to do it because they have the staff and expertise for gauging how much to do and when to stop." Second, there would be greater maturity diversification in Treasury issues, raising the expected value of debt service costs but reducing the vulnerability to unexpected fluctuations in interest rates.
How important is the issue of maturity diversification? A commenter (identified only as JKH) on Harless' blog thinks that it would be irresponsible to ignore it:
As far as the Treasury is concerned, it’s just acting according to prudent interest rate risk management considerations in locking in some interest cost on such a massive prospective debt load. It’s just a matter of judgement on how to diversify maturities, given the “risk” that the Fed may want to start tightening some time. Ignoring the issue of maturity mix is irresponsible. From there it’s judgement on the right mix.
This is fair enough as far as it goes, but what are the principles on the basis of which such judgment ought to be exercised? The trade-off here is between the expected costs of debt service and the risk of facing a situation in which costs are much greater than forecast. The basic problem was expressed very succinctly by Richard Roll (1971) as follows:
For example, consider a government agency borrowing for a specific long term project at currently high rate levels. It might be able to reduce the total expected interest payments (and expected taxes) by financing the project partly with short-term bonds rather than entirely with bonds whose term-to-maturity matches the project's life. On the other hand, even though the agency expects lower rates in the future, it would not feel secure in funding the entire project with short-term bonds that would require a later refinancing. It would prefer to pay the higher expected rate on a portfolio of long- and short-term bonds rather than accept the risk that rates will go higher contrary to expectations.
Given some specification of Treasury preferences and expectations about the future course of interest rates, this is a fairly standard optimization problem. But it is not obvious (at least to me) how the desired maturity structure should vary with changes in uncertainty about future rates. Other things equal, greater uncertainty should lengthen maturities. However, greater uncertainty will also steepen the yield curve and raise the expected costs of long-term (relative to short-term) financing, and this effect should reduce desired maturities. In any case, these effects should be possible to identify, given some specification of Treasury objectives.
Much more difficult is the question of what those objectives ought to be. How much weight should by placed on risk as opposed to the expected costs of debt service? And should the desired maturity structure of government debt be sensitive to macroeconomic conditions?
I don't have answers to these questions but (as I said in a comment on Mark Thoma's page) it is important to resist the temptation to view the problem solely from a corporate finance perspective. There will be a significant shortfall in government revenues over outlays for many years to come, so short-term Treasury issues will have to be rolled over repeatedly for an indefinite period, or converted to long-term debt at some point. If this were a corporation, such financial practices would be madness (for the company as well as its creditors). The company would be engaged in massive maturity transformation, and be highly vulnerable to changes in short term interest rates and credit availability. It would be unable to meet even interest obligations without borrowing - which is Hyman Minsky's definition of Ponzi finance.  
But the Treasury is not a private corporation, and it faces very different constraints and objectives. Matching maturities to expected net revenues is simply not an option, nor should it necessarily be a goal. This much is straightforward. Much less clear is the set of principles that ought to guide the decisions that ultimately determine the maturity structure of government debt.


Update (12/28). In an email to me (posted with permission), Joe Gagnon adds:
Since the government includes the Treasury and the central bank, we could have one objective function and find the optimal policy from first principles. But I suspect the same result would obtain if the Treasury acted as first mover and followed a reasonable, modestly risk-averse, cost-minimizing strategy for maturity of issuance given the Congressionally set taxes and spending. Then the central bank would take Treasury behavior as given when it decides on the optimal maturity structure from the overall social welfare viewpoint, taking into consideration unemployment and inflation as well as risks to government finance and likely future behavior of Congress.

My own sense (buttressed by Table 6 in my paper) is that the risks to government finance from shifting into short maturities is very small compared to the benefits, and much less costly than outright fiscal-spending stimulus.
The point about the table is that even in the inflation scare scenario, when future short rates rise quite high for a while, the debt burden is lower with monetary stimulus (via maturity transformation) than without it. Of course, one can construct even more extreme scenarios in which that is not true (or in which the debt burden is reduced by high inflation) but I would argue those scenarios are highly unlikely given the state of the economy and the current membership of the Fed’s policy committee.


  1. Professor,

    Sorry about the thread hijack, but is there anyway you could post some of your older papers to your website?

    I understand if there are copyright issues with the journals where the papers are published. But you have some older papers concerning norms and financial instability that I think a wider audience would be interested in.

    I have read several of your papers on crime and segregation, and have found each one fascinating. In many respects they have changed my views on the issues. Especially about the analytical emptiness of the concept of a "subculture of violence."

  2. Just email me with a specific request and I'll send you a copy... all abstracts are online.

  3. Rajiv,

    How about this:

    The overnight rate is 0.25% and the interest rate paid is also that. The Fed removes the word "overdraft" from its dictionary as far as the Treasury is concerned. The reserves created by government spending just lies at the Fed.

    Ever checked this site ?
    Checkout the "7 Deadly Innocent Frauds" on the left.

  4. Yes, I've looked at Mosler's site and read the first part (chapters 1-7 on the deadly innocent frauds) of the manuscript. I'm not sure what his position would be on maturity structure. I suspect that he would consider it to be a distributional issue: given any level of the deficit, a higher interest component would shift resources to bond holders and away from other taxpayers.

  5. I know his position on this - just don't issue any Treasuries! And that is not a joke. He is serious about it and I have reasons to believe him.


  7. It's an interesting idea, and it would flatten the yield curve. (The Harless and Gagnon proposals would also do this.) But it seems to me that it would put the Treasury in control of the money supply and substantially reduce Fed independence.

  8. If you want to ground this analysis in fundamentals -- that is, if you want to evaluate this not as Richard Roll would do, from the false analogy of gov't agency as pseudo-firm, but as an extension of monetary policy by other means -- then I think you have to start with Barro and Ricardian Equivalence.

    Why does the gov't borrow at all? Why not finance entirely from taxes and seigniorage?

    In place of our current situation, imagine another extremity: imagine it is the U.S. in 1944 -- straining overemployment of every real resource, the price matrix barely contained by extensive systems of rationing and fiat price controls, income tax rates very high, excise taxes on everything. Why is the government borrowing vast sums? Why does the government print vast quantities of war bonds and exchange them for its own currency?

    A marketable national debt is just an extension of the currency through time. But, what function does that serve in the economic system? How does it relate to the price matrix?

    If currency facilitates non-barter market exchange transactions, what does money in the form of bonds of various terms accomplish?

    These are the fundamental questions, in which to ground your speculation.

    Look to 1725, when France and Britain, rival would-be hegemons of the world, were both struggling to establish systems of finance suitable to a post-feudal age. An opportunity to create a currency tied to the management of a marketable national debt somehow got mixed up with overseas trade monopolies.

    The South Sea Bubble ended with the Bank of England absorbing its larger rival, the South Sea Co., England's credit was never again questioned, the cost of national debt service settled to risk-less levels, the landed aristocracy and landed gentry got busy with the industrial revolution, canals and steam engines, wedgewood and evolution, and so on.

    Law's Mississippi scheme spiraled out of control, France staggered on, overloaded with a corrupt aristocracy unwilling to pay taxes, to lose its Empire, and then the head of the King.

    There, in 1725, is the infant birth of monetary policy, grounded in the management of a marketable national debt.

  9. Hi Rajiv,

    I guess I do not fully understand Harless's idea:

    1. Indeed money and bills are virtually identical assets now. That's exactly the consequence of an expansionary monetary policy, and the resulting zero bound problem has rendered further monetary expansion ineffective.

    But why does it follow that an increase in the Treasury's issuance of bills would have expansionary effects? I thought it's the opposite: that by issuing more bills, the Treasury would bid up the interest rate, making bills less than identical with money and drawing liquidity out of the economy.

    2. In fact, I thought the starting last Sep., Treasury has been draining liquidity on behalf of the Fed by issuing securities and keeping the funds in its Supplementary account at the Fed. i.e. the Treasury has been issuing security not as an expansionary effort but as a contractionary effort. Although it seems such effort has been significantly toned down since this Sep. the Treasury now still deposits some 15 billion in its Supplementary account:

    3. The banks are still sitting on their reserves. Why would pumping more money into the economy help?[1][id]=BOGAMBSL&s[1][range]=5yrs

    More importantly, the money base is still increasing:

  10. Rajiv,

    The philosophy of Warren Mosler and his collegues Randall Wray from UMKC and Bill Mitchell from Australia, and other colleagues is very different from mainstream economics. But in fact makes complete sense to me.

    Briefly, the idea is that the central bank cannot control the money supply, not the overnight interest rate. Banks lend and then look for reserves to satisfy reserve requirements if any. (Some countries don't have them). More loans lead to an increase in money supply via deposit creation. Any attempt by the Fed to control this will not be consistent with overnight rate targeting. In other words, the Fed cannot control both the money supply and the interest rate. So money is "endogenous".

    Even if we include the government sector in this approach, things are not different as far as endogeneity is concerned. Higher economic activity leads to higher taxes and more saving leads to higher deficits through automatic stabilizers.

    Harless's post seemed interesting but I guess his suspicions are already known to "Chartalists". Any financial asset is someone else's liability and the net financial assets of a closed economy is zero. So the net worth of a closed economy consists of real assets - those such as houses which are not someone's liability. If we slice this into government and non-government sector, the financial assets of the private sector sums to the public debt. Hence, there is nothing wrong with public debt for a nation with a sovereign currency. The only risk, then is price stability so the government needs to spend as much as the private sector desires to save and not consume.

    Back to the term structure - the Treasury and the central bank together can work and set the yield curve. The way to do it is: issue Treasuries at any maturity you want but announces the price (and hence the yield). For each maturity say 1,2,3 .. the number of bonds purchased will be N1, N2, N3 and this will be determined by the preferences of buyers. Bond sales by the government drains reserves and it is likely that there is an excess of reserves - they just stay with the banks and earn the interest paid on reserves by the Fed. (For a broader participation, 1-day T-bills can be issued).

    This is tricky and the reason a corporate cannot do it is because they are not the monopoly issuer of fiat currency. On the other hand the government can spend easily - it just credits bank accounts of the payee and compensates banks by increasing the reserves. This is an "overdraft" but in a fiat system hardly worrisome. Taxes would work in the opposite way, debiting bank accounts of the payer and decrease of reserve.

    Now since the Treasury/Fed can set the yield curve in principle (and in practice), the question is what should it be. The only way to get an answer is to ask which one serves public policy better ? Hence Warren has argued that the interest rate be set to zero - in other words - call for a Euthanasia of the rentier.

  11. Second para, first line in the comment above should read;

    Briefly, the conjecture is that the central bank cannot control the money supply, only the overnight interest rate

  12. J., the expansionary effects of both proposals (Harless and Gagnon) work through lower long-term rates. In the Harless scenario the deficit is held fixed while the Treasury issues bills instead of bonds, thus flattening the yield curve. Whether or not this will stimulate investment is another matter, but that's what he is arguing in any case.

    Ramanan, I'm familiar with (and broadly sympathetic to) the post-Keynesian view of this but I don't see the Mosler proposal as being realistic or necessarily even beneficial. It might work well if the level and composition of government expenditure were independent of the manner of its financing (as he would like it to be). But I suspect that if we really did do away with Treasuries, we would see a very different amount and composition of government expenditure.

  13. Rajiv,

    I don't understand "composition" of government expenditures.

    Hardest part to get this to people: It is upto the government to issue Treasuries. Does not really affect the spending side. The budget identity is not a constraint - just an ex-post identity.


  14. Ramanan, of course I understand that government expenditures are determined by congress and not by bondholders... what I was saying is that having to auction Treasuries each week creates a different set of incentives than would be in place if the deficit were immediately monetized. That's all.

  15. Harless said in his comment at Economist’s view:

    “Presumably, as long as there is a serious risk of non-positive inflation, the Fed will continue its zero interest rate policy, which is essentially a commitment to buy, at zero discount, any bills that the Treasury chooses to issue and cannot sell to the public at a zero discount. If the Treasury were to shift all its financing to the short end of the curve, the Fed (unless it were already confident in a positive inflation rate) would buy up all the excess T-bills. So the immediate effect of such a shift would be that an even larger part of the deficit would be financed by creating base money.”

    I don’t know where he gets that idea. It’s nonsense. There is no such price commitment regarding bills. The “zero rate policy” current is a commitment to a Fed funds range of zero to 25 basis points. It pertains to the interbank lending rate, not to bills. Treasury can issue bills any time it wants without offending the zero rate policy. In fact, what Harless believes the zero rate policy to be is closer to what Mosler thinks it should be as a matter of structural permanence, where no government debt is issued.

    I left a longer comment on Harless’ blog regarding other issues.

  16. Mosler’s “zero natural rate” proposal (with no government debt) is not necessarily a central feature of the “modern monetary theory” branch of PK economics. Mosler himself has made the point that the main idea of MMT (or “Chartalism”) is a proper understanding of how a fiat monetary system works in its basic form. With that understanding, new policy choices open up. The leading MMT advocates have made their preferred choices, such as a permanent zero rate policy and employer of last resort. But MMT offers the only accurate description of how the monetary system works as it exists now, even without additional fundamental changes being implemented.

  17. Treasury bills are not the same as money, whether the rate on them is 10 per cent, 0 per cent, or (10) per cent. It’s more the case that money in a liquidity trap begins to take on the characteristics of a 0 per cent treasury bill, rather than vice versa. The trap immobilizes money, more or less, which is equivalent to a reduction in velocity, which is equivalent to a lengthening of what is an implied term structure of money as a financial asset. Deficit spending as per the MMT prescription creates income and saving at the macro level as an automatic result. The point is that the non government sector has a yet to be satiated appetite for saving in a liquidity trap type recession. That saving demand can only be satiated by the government continuing to supply net saving until it is. Whether that saving is captured by issuing treasury bills or bonds or leaving it in the form of money and excess reserves is moot in terms of the saving phenomenon. The government could do that either the way that it does now – by a mix of bills and bonds – or the Mosler way – by effectively jamming the entire operation through the banking system with additional broad money and reserves created as a result. Either way, it is the demand for saving that must be satiated, not the demand for money. That’s because money takes on the characteristics of a zero rate treasury bill, and the choice between money issuance and bill issuance really isn’t important under such conditions.

  18. JKH, first of all, welcome... I'm happy to have your perspective on this blog.

    I can't speak for Harless, but I imagine that he would argue that the interbank lending rate and the rate on bills cannot diverge much otherwise it would set up an arbitrage opportunity. So any targeting of the interbank lending rate will effectively hold down the rate on bills.

    Your point about money taking on the characteristics of bills when interest rates are close to zero (rather than vice versa) is excellent, I agree completely.

    Regarding the "proper" amount of maturity diversification, I don't think it's enough to simply rely on common sense. Underlying any judgment call about the right mix is an implicit trade-off between risk and expected cost. Two people with equal endowments of common sense could come to very different conclusions about this, depending on their degree of risk aversion. I don't think that common sense can tell us what the appropriate degree of risk-aversion for the Treasury should be. Having said that, I don't really have any quarrel with the mix you proposed in your latest comment on Harless'.

    I have updated this post to add some comments by Joe Gagnon, in case you're interested.

  19. (added before I saw your latest comment)

    Furthermore, the choice between money and bills in the current system is equivalent to a choice between paying interest on excess reserves and paying interest on bills, which won’t be materially different whether it’s now or in the future (interest costs on reserves right now are only $ 2.5 billion per trillion). It’s the choice between money/bills versus bonds that becomes relevant for the trajectory of deficit financing interest costs in the future, not the choice between money and bills. Which goes to earlier points made.

  20. I agree completely with your 2:25, if you can believe both at the same time. Mine was a point written hastily and deliberately loose. What I mean really is that your basic idea about risk/expected cost trade off is one of common sense, where common sense means some familiarity with the idea of risk versus return in finance. I don’t know how exactly to calibrate that trade-off precisely in this case, which is why I was somewhat loose in the formulation. I don’t think there is a precise formulation as a holy grail. Better to be vaguely right than precisely wrong. I realize that doesn’t get us very far in terms of your original question, but it maybe it helps in the conceptualization of how the answer should be framed.

  21. Yes, if your point was that we shouldn't ignore the maturity diversification issue (which Harless seemed to be doing) then we are in agreement.

  22. Rajiv,

    I'll read Gagnon's paper and come back with any comments.

  23. JKH,

    A few IMOs:

    Completely agree with you on description of the "Modern Money" gang of the monetary and economic system even without fundamental changes. However, it also offers an insight that the yield curve can be made exogenous. Unlike a corporate which may try to play the yield curve considering the balance sheet implications (with the help of bankers) to raise debt, a government need not do it. With this understanding, it (deciding the exogeneity) becomes a question of political economy. Here is an article which considers many things.


    Just glanced the pdf - yet to read it myself! Considers zero overnight rates as well.

  24. Rajiv,

    Again I agree with the general idea of not being too risk averse in terms of maintaining a “reasonably” short duration for Treasury debt. But there is no precise algorithm for the ideal duration target.

    The duration is probably more difficult for government debt than is a comparable asset liability management decision for a financial institution or corporation. The core reason I think is that governments run net liability balance sheets, whereas financial institutions and corporations run matched balance sheets. Another way to look at this is that governments run negative equity positions at a purely technical balance sheet level. Even if there are occasional surpluses, or periods of relative balance, this negative equity position is in a long term structural uptrend. In the case of the US, one would hope for a period of relative flattening starting in a few years time, assuming that economic growth will deliver tax revenues that are more in balance with expenditures than now. But it is delusional to pretend that the net liability position must eventually be “paid back” with taxes. This is a fundamental problem with mainstream analysis, I think.

    So the liability duration problem must consider the existence of this net liability profile more or less forever. I’m not sure what that means for the duration decision, but the structural endurance of the net liability profile is a reasonable expectation in my view.

    Then consider the composition of the net liability position. PK MMT economics is helpful in immediately recognizing the components as bank reserves, currency, and debt. These are all associated with cumulative deficits and the trajectory of the net liability position over time. Normally, reserves and currency together are a relatively modest share of the net liability.

    Reserves are currently outsized and priced for short duration. It’s interesting that the Fed is making increasing noises about paying interest on reserves at a fixed rate using “term deposits”, which extends duration slightly.

    Currency is interesting from a duration perspective. Commercial banks face a similar decision in the duration treatment of “core deposits” whose interest rate sensitivity may be somewhat muted relative to Fed funds repricing risk. So there’s an argument that currency is effectively a long duration instrument. Because it pays no interest, it hedges interest rate risk relative to fed funds, just like long term fixed rate debt.

    That leaves the main piece, which is treasury debt. But I really don’t have any new ideas to offer in terms of an optimal duration target, be it for debt or for the consolidated liability position.

    I skimmed the Gagnon piece. There’s a lot I’m not qualified to judge there. But I agree that the smart way to view this issue is to consider the treasury and central bank balance sheet on a consolidated basis (the PK MMT automatic view). There are operational considerations he points out that are relevant to deconsolidated analysis, but the overall duration result is best viewed consolidated. The duration result depends on Treasury doing proactive duration shifting in new issues, and the Fed buying up debt and issuing reserves instead. Just about any duration target can be achieved through these various operational means.

    I find it interesting that the paper emphasizes the role of the recommended “monetary policy” as influencing the term structure of interest rates, rather than emphasizing the actual money effect of the intervention in either base or broad terms. I’m completely unconvinced by most arguments along the latter lines. But a $ 2 trillion intervention could have substantial implications for the yield curve, starting at the short end with both the interest rate on reserves and Treasury bill rates. It really exports normal Fed interest rate policy out the curve in a sense. And given the potential role for excess bank reserves in facilitating the duration shift, again it requires an integrated Treasury/central bank view of things.

  25. Ramanan,

    Thanks for the link. I'll have a look.

  26. Ramanan,

    I'm familiar with the exogenous yield curve structural option under PK MMT.

    But it can't be made exogenous while continuing with an auction facility. I'm assuming the latter in this case.

  27. P.S. Ramanan,

    You're making a lot of good comments all over the place.

    Must have been a very rewarding conference in Australia!

  28. Dear JKH,

    Thanks for the compliment!

    Yes with an auction kind of setup, it cannot be exogenous which is why Bill keeps writing about the replacement of the "tap system" with the auction system.

    Yes the conference was great. Plus I got on stage with Randy, Warren and Bill in a workshop on Modern Money. In a party before the conference started, Warren told me if one figures out a few organising principles - then things start falling into places. Like "Money as a public monopoly". He has these one-liners which are deep. Plus in the workshop I began to appreciate the banking system as a public-private-partnership concept.

  29. JKH, you make some excellent points and I have very little to add. Governments do indeed run net liability positions and the extent to which they do so is itself indeterminate: there is a large range of debt to GDP ratios that can be indefinitely sustained. You are also correct in observing that many mainstream models do not allow for this, since they impose intertemporal budget balance.

    Another important difference between governments and corporations is that the government is not vulnerable to asset liquidation by its creditors. This, I think, is even more relevant to the liability duration question. It allows for a much shorter maturity structure than could prudently be chosen by a firm. Some theories of corporate maturity choice build on the desire to avoid premature liquidation; I mentioned the work of Douglas Diamond in an earlier post. This concern is obviously irrelevant for Treasury maturity choices. Nevertheless, as you pointed out on Harless' blog, complete reliance on short-term financing by the Treasury would be irresponsible for risk-management reasons.

    You have an interesting way of putting things: I especially like the negative net equity position of the government, and the idea that money takes on the characteristics of bills (rather than the reverse) when interest rates are close to zero.

  30. Rajiv,

    Another PK insight is that public debts and deficits are endogenous numbers - totally outside the control of the government, entirely decided by the propensities of the domestic private sector and the external sector. The choice of exogeneity of the yield curve for a sovereign government becomes important because of this. The only important decider for playing with the yield curve is "public purpose". That sounds like taking a socialist view but there is no other way to decide. The public debt and the "expected path" are just numbers.

    Actually very few PKists actually realize the endogeneity of public debt and the choices that opens up with this understanding.

    Let us suppose that one decides on a maturity diversification. So what ? During coupon payments, principal payments and raising new debt, (which happens almost everyday), the economy might be in a situation which was not expected. The economy may need pure government expenditures as opposed to interest payments. The economy may need higher taxes to control aggregate demand. Since the government has no contraints, it is better to decide fiscal policy quarter-by-quarter than make projections and modify it later. Deciding on a term/maturity structure is like programming your car for an auopilot mode to go out and then struggling with the program to handle traffic. A better way is to just control the car by having your hands on the steering wheel.

    JKH always has his way of putting things. Always great to read his comments (read insights)

  31. Rajiv,

    The attitude in my previous comment is that the private sector is inherently cyclical and the government should do all it can to reduce this instead of adding to it.

  32. Rajiv,

    Thanks. Here’s a concluding point regarding the broader question of how a government manages its balance sheet in total.

    Corporations and especially banks must be concerned about a range of risks, including the big ones of solvency and liquidity. Liquidity risk is often the channel through which solvency risk (real or perceived) is galvanized – i.e. the classic bank run as the product of depositors’ fears for the institution’s solvency.

    Because the government is a fiat currency issuer, it has the capacity to literally create its own liquidity. This means that solvency risks facing corporations are not the same type of issue for currency issuing governments. I.e. liquidity dominates solvency in the case of governments, rather than vice versa as for corporations. The government’s liquidity capacity allows it to run a net liability or negative equity position. From a PK MMT (“modern monetary theory”) perspective, this is close to the idea that governments create “net saving” for the non government sector, as a matter of satisfying the demand for such saving, particularly in recessionary or “liquidity trap” environments as we have now. Broadly speaking, that net saving result improves the non government sector liquidity profile. It’s an extension of the idea of the demand for money.

    This is a point I’ve been meaning to make on some of the post Keynesian blogs. It fits here as well, because the government’s liquidity power also affects it’s capability with respect to other types of risk – interest rate risk specifically in this case. The liquidity/net liability/negative equity capacity allows the government to adopt an interest rate risk profile that wouldn’t be prudent in the context of a corporate or bank balance sheet.

  33. P.S.

    By creating its own liquidity, I mean the capacity to issue liquid liabilities. This obviates the normal (private sector) requirement to maintain some sort of stock of liquid assets as well. Private sector liquidity management includes elements of asset liquidity (the ability to encash), liability liquidity (the ability to issue), and capital (long term insurance). Governments only requires the liability piece.