The power of the middlemen

The state budget is one of the most essential tools of public policy, with an increasing proportion derived from sovereign borrowing in financial markets. Central banks are prohibited from directly financing governments by purchasing their debt. The rationale behind this strict separation between fiscal and monetary policy is based on the assumption that governments may be inclined to overspend in pursuit of re-election, potentially leading to inflation. As a result, central banks are granted independence from government influence and are not subject to democratic procedures to focus exclusively on the apparently technocratic task of maintaining price stability. Consequently, governments need to rely on private banks for funding, thereby subjecting a critical aspect of state sovereignty to the interests of profit-driven private creditors. To stabilize their relationship with lenders, most states have established a primary dealer system, granting a select group of banks privileged access to sovereign debt and other benefits to ensure their consistent participation in sovereign debt auctions. Furthermore, although central banks are prohibited from directly purchasing sovereign debt from the debt management offices that issue it, they have a vested interest in maintaining a stable sovereign debt market to preserve financial and price stability. Therefore, central banks engage in sovereign debt markets primarily through primary dealers, purchasing sovereign debt from them and providing them with liquidity to stabilize investment in sovereign debt markets. This project seeks to unpack some of the power dynamics between private finance and the state within sovereign debt markets, specifically in the context of independent central banks. It does so by examining the complex relationships between primary dealers, debt management offices, and national central banks through a comparative political economy lens and by employing a mixed-methods approach.