Debt monetization

This post is slightly different from the main purpose of this blog. Nonetheless, it is still relevant for the sake of the discussion. We all know that the COVID-19 pandemic brought significant economic losses, mainly due to lockdown that was imposed by the government, and social distancing that restricted mobility. To repair the damages, government increased spending by issuing debt. Central banks increased money supply and slashed down interest rates to ensure that liquidity is sufficient in the financial market.

We also witnessed that, practically, the central bank can also implement unconventional policies. For example, last year, Bank Indonesia and Bangko Sentral ng Pilipinas (Central Bank of the Philippines) implemented debt monetization. 

Debt monetization refers to a situation where the central bank directly buys debt issued by the government. This is much easier to explain from an accounting perspective, where when a government issues debt (government's liability), the central bank buys it, and it becomes its asset. In exchange, the central bank will issue currency (central bank's liability), and it becomes the government's asset. Technically, it sounds like quantitative easing, but with a different end goal.

This is unique, especially when central banks from emerging economies decided to implement it. Looking at this from a bigger picture, I will say that this can help central banks to avoid falling into the zero lower bound problem. 

In my next post, I will explain how this is relevant by illustrating its mechanism using the IS-LM curve and its caveats.