So if a government wants to borrow money it issues bonds at a fixed interest rate at a certain maturity date? How does it know what to set that rate at? Bonds are sold on the secondary market at market value but that is just between private investors right?
How does the secondary market price impact how the government services its debt given they will just offer par 100 at 4%?
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> if a government wants to borrow money it issues bonds at a fixed interest rate
Government bond interest rates are not fixed. They are set at auction.
Government: Here’s an IOU. It says “I pay you $100 in yearly installments over the next 20 years — US government” and this crowd of bidders has assembled to buy it today.
Auctioneer: Do I hear $50? $70 from the man in the red shirt. Okay, I hear $75 from the woman from BigCapital Megafund. JP Morgan, with your hand in the air, $80. Last National Bank, $86. $86 from Last National, any other bids? Going once…Going twice…SOLD to Last National Bank.”
Then Last National Bank pays the government $86 when the auction ends. According to the IOU, the government pays Last National Bank $5 a year for the next 20 years.
Except the auction process isn’t a live auction, it’s done by everyone sending their bids to a government computer system that can handle thousands of bidders. After the deadline for submitting bids, the computer calculates the auction results.
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