In a comment within a recent Fiat Thread, our esteemed colleague, u/RobThorpe, discusses a conversation between /u/MachineTeaching, /u/BlackenedPies, and myself that occurred in r/AskEconomics on whether or not a government issuing a bond affects the money supply.

My contribution to that discussion was to point out that if a depository institution (i.e. a bank that can create liquid deposits and holds reserves to service those deposits, not merely a middle man like a primary dealer) buys a newly issued government bond and the government spends those funds then the money supply will have increased by the amount the bank paid for the bond. This is money creation by a bank, just as if the bank made a loan to a person or a firm. I also pointed out that if the bond was purchased by a non-bank then the money supply would not change as a result of that transaction, as money simply transfers from the bond buyer, to the government, and then to whomever the government pays. This is important because it means that issuing bonds does not necessarily increase the money supply. Only when depository institutions or the central bank gets involved can the money supply be affected by a financial transaction.

This kind of money creation can occur even if the bank buys the bond on the secondary market from a non-bank. With this in mind, it is clear that it does not matter if the bank goes through an intermediary, like a primary dealer or a broker, to buy the bond.

Within the comment on the Fiat Thread, Rob correctly points out that if somebody pays a tax the money supply is not affected, and that this occurs regardless of whether monetary policy is conducted within an abundant or scarce reserves regime:

Through the loop the money supply hasn't changed. This means that if the amount in the treasury general account doesn't change much then taxes will not change the money supply much. This is the same situation we saw for the restricted reserves system.

One point where Rob went wrong is by claiming that in terms of its affect on the money supply a bond is no different than a tax:

So, if the balance held in the treasury general account doesn't change much then there is no overall effect. Money supply shrinks by t x M and then grows by t x M - where t is the tax take and M the money multiplier. Of course, the same applies if the input balance comes from the sale of a bond rather than from tax.

and

As before bond purchases act in a similar way to tax payment.

I have already explained why this is not always correct in my previous commentary, so I will respond to this by quoting myself:

If the US government sells $1T in additional bonds to depository institutions then that $1T credits the Treasury General Account (TGA) at the Federal Reserve. For depository institutions, the accounting on this would be a decrease in the reserves of depository institutions and an increase in their bond holdings.
Then if the government pays private contractors and workers this $1T then their deposit accounts will increase accordingly. This will also bring both bank reserves and the TGA back to where they were initially.
What's changed? There is an increase in deposits at these private depository institutions to match the increases in their bond holdings. As there is no change in the amount of currency in circulation (yet), the increase in deposits represents an increase in the money supply.

Another argument is given in my initial response to Rob, which is based on Section 2 of this paper. In that argument I also point out that a bank buying a bond does not always increase the money supply. In particular, if the bond was paid for entirely by some combination of crediting an illiquid liability of the bank's or by issuing equity then the money supply would not change. Also, if a bank uses reserves to buy a bond from the central bank then the money supply would not increase.

Rob proceeds to assert that BlackenedPies and I went wrong because we start from reserves:

So, why do ExpectedSurprisal and BlackenedPies come to a different conclusion? This is because they start from reserves. They begin from a bank holding a quantity of reserves and deciding to spend those reserves. This is a very important assumption. Compare it any other sort of investment -not necessarily government debt. In any case when a bank decides to commit reserves to an investment it will create money. That's true if the bank buys shares, or if it makes a loan. Those things will create balances in the sellers accounts. New balances that are not offset by a fall in any other balance.

Rob continues, asserting that starting from reserves is problematic because the US government sells bonds to primary dealers, which, typically do not hold reserves as they are not depository institutions, though they may serve as a middle man between actual banks and a government:

Starting from reserves is problematic though. That's partly because bond primary dealers are not actually banks. Rather, they are usually subsidiaries of banks. They are usually owned by a bank holding company but are not banks themselves.[1] As a result, their bank balances are already M1 money supply. Suppose that a primary dealer buys a bond for $1000. It already must have $1000 in it's account at it's parent bank. This $1000 is temporarily removed from the money supply as it passes through the treasury general account and becomes money again on the other side.

I doubt that it was intentional, but Rob is committing the strawman fallacy here; Rob is arguing against something that neither BlackenedPies nor I wrote. Rob should not have presumed that we were claiming that a non-depository primary dealer could affect the money supply. In my writing on this I have always been explicit about using "depository institution" or, more succinctly, "bank" when discussing this topic (and I do this to a fault, as my quote above illustrates). Also, I am convinced based on subsequent discussion in Rob's thread that BlackenedPies understands the difference between actual banks and primary dealers as well.

Okay, so if we were not talking about primary dealers holding the bonds, are BlackenedPies and I nonetheless mistaken because we are starting from reserves? No, because starting from reserves is not necessary for our conclusion that when depository institutions acquire bonds they can increase the money supply (depending on how the acquisition was financed). To see why, imagine a government that issues a bond directly to a bank in exchange for the bank crediting the deposit account of a government contractor. This clearly increases the money supply by whatever amount the bank credited the account. Another example would be if a government had an account with a private depository institution and exchanged a bond to this bank for a credit to the government's account. Again, it's obvious that this increases the money supply (assuming a government deposit account at a private bank counts as money). To reiterate my point: These examples show is that starting from reserves is not necessary for arriving at the conclusion that bond issuance can affect the money supply.

I won't speak for BlackenedPies, but I'll note here that the reason I mentioned reserves in my initial comment is because that's closer to how things currently work in most economies, and I didn't want to deal with anybody quibbling with me along the lines of, "Actually, banks need to transfer their reserves in order to buy the bond and this occurs in way X within country Y under regulatory regime Z." Such a person would be needlessly missing and undermining my point over details that are negligible, nonuniversal, and subject to change over time.

As I just hinted, I think part of the problem here is that people get entangled in the details of what currently happens in some particular economy when these transactions occur. Do not get me wrong; there is value in knowing that there are middle men, like primary dealers and brokers, and it is good to know how treasury accounts of various governments work. However, such details do not change the essentials. Here, the fact that depository institutions may not necessarily buy bonds directly from the government does not matter in terms of the effects of such transactions on the money supply. As my examples above show, one can simply ignore any middle men and ignore the money going into the government's official treasury account and still arrive at the correct conclusion. In fact, ignoring them may help you get there faster because you're less likely to get derailed by minutia.

Again, I don't think Rob purposeful strawmanned us. And I don't fault Rob or MachineTeaching for getting these things incorrect. There has been a lot of confusion (even in textbooks and well-known academic papers) over the topics of money creation and the money multiplier for a long time, but I do hope that these discussions will lift the fog a bit on these topics.