Government in the Money View: Sovereign Debt, Liquidity Preference, and the Fiscal-Monetary Nexus

In times of financial crisis, we expect monetary authorities to provide liquidity support to banks at risk of failure. However, governments often provide monetary support to banks at risk of failure through guarantees and direct lending to financial institutions, often in tandem with monetary authorities. At the same time, governments may require liquidity support in moments of crisis, when cyclical deficits rise, and bond market activity constrains access to funding. This paper introduces governments’ activity into both the Post-Keynesian theory of endogenous money as well as Mehrling’s ‘Money View’ of the economy. It demonstrates how government activity becomes more important during periods of heightened liquidity preference through its support of financial institutions, while governments may simultaneously become more vulnerable to private bondholders increased liquidity preference. Some governments are likely to face greater obstacles in providing liquidity and accessing funding in times of economic uncertainty, while others may find their ability to provide liquidity is bolstered by popular perceptions of their credit worthiness. Recent experiences during the Global Financial Crisis, the Eurozone Crisis, and the COVID-19 Crisis 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 economic development.