Indifference Between State Money and Public Debt

This chapter further dwells on the value of money and other instruments issued by the public sector when they are traded in globalized markets and its reflections on macro-policy effectiveness. The famous capital structure irrelevance principle of Modigliani and Miller, American Economic Review 48:261–297, (1958) is used to show that when international capital allocation choices are determined by well-informed, deep-pocketed Global investors, there are no net gains a government of a financially integrated economy can consistently extract from resorting to one type of deficit financing (say, debt) versus another (say, money) or by issuing debt in one form versus another. In particular, the approach is used to show that the cost of the capital needed by governments to finance their deficits is independent of whether: (i) financing originates from debt or money, (ii) debt is denominated in domestic or foreign currency, and (iii) money and debt are issued under floating or fixed exchange rates. The theorem’s two corollaries show that governments seeking to monetize their deficits must remunerate money holdings with a real return that varies inversely with credibility and directly with the stock of money.