Do taxes and bonds finance government spending?

Debates over the impacts of various ways of financing government deficits and about the relative impact of monetary and fiscal policy have, unfortunately, been carried out without recognition of the institutional process by which modern government spending, borrowing, and taxation are accomplished. 1 In the United States, close cooperation between the Treasury, the Federal Reserve System, and depository institutions makes the traditional distinctions between monetary and fiscal policy hard to use in describing actual processes and renders irrelevant many of the theories about the most appropriate mix of borrowing and taxation. Indeed, the entire treatment of taxation and of government borrowing assumes a monetary system quite unlike that of the modern U.S. system. My purpose in this paper is to describe, in some detail, the way in which the Treasury and the Federal Reserve coordinate policies that are neither purely fiscal nor purely monetary and to argue that theories of monetary/fiscal policy should incorporate more discussion of the issues of reserve management.