Government spending with increasing risk: sovereign debt, liquidity preference, and the fiscal-monetary nexus

Abstract

During financial and economic crises, government expenditure is a potential source of liquidity and replacement for private demand; this expenditure, in turn, generates more deposits and spending in the economy at large, potentially increasing the endogenous supply of money and overall liquidity in a given economy. Governments may also require liquidity support during crises, if bond market activity constrains access to funding. This paper introduces government activity to Mott’s elaboration of Kalecki’s theory of increasing risk, and its implications for endogenous money creation, especially during periods of heightened liquidity preference. Some governments are likely to face greater obstacles in providing liquidity and accessing funding in times of economic uncertainty, whether due to their issuance of a non-sovereign currency, their position in the global currency hierarchy, or both, while others may find their ability to provide liquidity is bolstered by popular perceptions of their credit worthiness. Recent crises illustrate the importance of understanding the monetary and financial factors that may constrain governments’ abilities to fund deficits, especially given the importance of fiscal expenditure as a stabilizing economic force, or as a potential driver of development.

Keywords:

• Risk
• liquidity
• Post Keynesian
• endogenous money
• fiscal policy

Acknowledgements

I gratefully acknowledge feedback from two anonymous reviewers, participants in the Analytical Political Economy Workshop in May 2021, participants at the Inaugural Tracy Mott Workshop at the University of Denver, in September 2022, and panel participants at the Money as a Democratic Medium conference in June 2023. I accept all responsibility for any remaining errors in the text.

Disclosure statement

No potential conflict of interest was reported by the author(s).

Notes

1 Examples include the central banks of Canada, the United States, the UK, Japan, the Eurozone, India, Korea, the Philippines, Thailand, Indonesia, Hungary, Israel, Poland, Romania, South Africa, Turkey, Mexico, Brazil, Chile, and Colombia (Cantú et al. 2021).

2 Bell (2000) notes that in the US, if the US government’s Treasury Department uses Treasury Deposit accounts for purchases and sale of bonds, total money in circulation may not be affected, because those institutions are not required to maintain proportional reserves. This example assumes a more general case in which the sale of a bond precedes expenditure.

3 Neo-chartalists object to the notion that a government may require funding, arguing instead that tax revenues or revenue from selling bonds merely takes money out of circulation (Bell 2000). For the purposes of this paper, we assume that taking money out of circulation has the same effect as funding expenditure, insofar as it balances the government’s spending in the economy. At the same time, the government of a non-currency sovereign economy may require foreign exchange for expenditure funded by bonds.

Additional information

Notes on contributors

Nina Eichacker

Nina Eichacker is an Assistant Professor in the Economics Department at the University of Rhode Island. Her work focuses on Post Keynesian theory, financial crisis, liquidity, and the interaction of fiscal and monetary policies.