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An argument could be constructed that the government could control amount of money circulating by on one hand regulate the CB rate and the conditions it is borrowed out under, and on the other give the opportunity to park your money with the state to suck up money that is not invested.

Yes. That's what interest rate policy does. Buying and selling government bonds is one way to enforce an interest rate policy (but neither the only nor the best one). Note also that interest rate policy is inherently destructive of economic activity: The CB can't create profitable investment opportunities where there are none, due to the zero bound on nominal rates; but it can destroy profitable investment opportunities by giving the prospective investors a risk-free yield above the internal rate of return on the investment in question.

So an interest rate based stability policy will tend to underperform a fiscal stability policy, all other things being equal. (Historically, all other things were not equal, because fiscal policy is traditionally decided once a year, while interest rate policy is decided continuously, giving interest rate policy an advantage in responsiveness. But that is an institutional idiosyncrasy, not an operational necessity.)

Then as a rule, the bond rate should be slightly below the CB rate

It's almost always above the CB rate. Often quite some way.

(if it is over banks can borrow from CB and to government, which is just another bank subsidy,

Yes. That is one of the reasons I call it a subsidy.

if it is far below you get a wide span where the profitability of investment does not depend on CB rate), and the amount that the government borrows should be irrelevant.

The Treasury yield can't go materially below the rediscount rate (unless the T-bond market is so thin that it becomes difficult to distinguish its existence at all).

If the Treasury rate is materially below the rediscount rate, banks will either dump Treasury bonds and pay back their debts to the CB with the proceeds, or (what comes to the same thing) offer non-bank holders deposit accounts with the same term structure but an interest rate somewhere between the T-bond rate and the rediscount rate.

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Wed Nov 23rd, 2011 at 03:28:15 PM EST
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