Not that they can’t, but why would it be bad policy to raise government revenues by issuing bonds that are then sold to the monetary authority? Here are some thoughts in relation to a fixed exchange system and a floating exchange rate system.

There is an inherent problem with financing government deficit spending by issuing domestic bonds. Under a fixed exchange rate one may discover the central bank (CB) purchasing domestic bonds at the expense of dwindling the foreign reserve (FR). One cannot simply print money to expand the supply, thus FR are depleted. However, if this continues, the CB will eventually find itself unable to support a fixed E. Speculation for collapse of fixed E (exchange) and increase domestic exchange rate will cause an abandonment of the fixed E when FR are gone. If the CB decides to simply print money to meet expanding money supply, there will be a subsequent increase in inflation which will have a depreciating pressure on the exchange rate. Under floating you could then be forced to devaluate your currency under this pressure.

Share This