Answer to Question #69531 in Macroeconomics for John

Question

Hi,

If Central banks can create money for quantitative easing and use this money yo buy bonds etc, why can't they just create money to pay off government debt?

Answer 1

When interest rates are at almost zero, central banks need to adopt different tactics - such as pumping money directly into the financial system. This process is known as quantitative easing, or QE.
To carry out QE central banks create money by buying securities, such as government bonds, from banks, with electronic cash that did not exist before. The new money swells the size of bank reserves in the economy by the quantity of assets purchased—hence "quantitative" easing. Like lowering interest rates, QE is supposed to stimulate the economy by encouraging banks to make more loans. The idea is that banks take the new money and buy assets to replace the ones they have sold to the central bank. That raises stock prices and lowers interest rates, which in turn boosts investment. If QE convinces markets that the central bank is serious about fighting deflation or high unemployment, then it can also boost economic activity by raising confidence.
Consequences of paying off the government debt: Increasing taxes by such large amounts is likely to lead to a recession and even a depression: businesses will pass on the costs of higher taxes to their consumers, with the increase in prices likely to lower demand for goods and services. Likewise, faced with higher taxes, individuals will have lower levels of disposable income, and, independent of the increase in prices this will negatively affect demand. Both factors will feed through to lower sales and therefore lower sales taxes, forcing the government to further increase taxes to hit its debt reduction target. Lower demand for goods and services will also lead to businesses cutting employment, lowering the government’s income from employment taxes. Higher levels of unemployment will also increase the government’s spending on unemployment benefits, which will have to be funded through further borrowing, again preventing the government from hitting its targets.
Alternatively the government could cut its spending. However, this is likely to have similar effects to increasing taxes. During recessions people tend to cut their spending – if the government cuts its spending at the same time the result can be a catastrophic drop in demand. It is important to remember that the nominal value of the debt is not actually important; it is the level of debt (and its maturity) relative to the earning capacity of the economy that is the important figure.
Consequently, quantitative easing is a monetary policy which creates to stimulate the economy, when standard monetary policy hasn’t efficiency. So as a result of payments for public debt, the real economy will not be activated, money will not be in active circulation. This may not correspond to the purpose of the country.
Sources:
https://www.bankofengland.co.uk
https://www.bbc.com
https://www.economist.com