14 - Deficits and the National Debt
from Part III - Government Debt
Summary
THE MODELS we have presented 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 critical 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 (e.g., currency) and one called government bonds (e.g., 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.
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- Modeling Monetary Economies , pp. 247 - 267Publisher: Cambridge University PressPrint publication year: 2011