When a sovereign government issues debt it logically
Answer: has no impact on the overall holdings of financial assets held by the non-government sector $-for-$.
The answer is Option (b) has no impact on the overall holdings of assets held by the non-government sector $-for-$.
The answer to this question is complementary to the answer in Question 3.
The fundamental principles that arise in a fiat monetary system are as follows.
National governments have cash operating accounts with their central bank. The specific arrangements vary by country but the principle remains the same.
When the government spends it debits these accounts and credits various bank accounts within the commercial banking system.
Deposits thus show up in a number of commercial banks as a reflection of the spending.
It may issue a cheque and post it to someone in the private sector whereupon that person will deposit the cheque at their bank.
It is the same effect as if it had have all been done electronically.
All federal spending happens like this. You will note that:
All the commercial banks maintain reserve accounts with the central bank within their system.
These accounts permit reserves to be managed and allows the clearing system to operate smoothly.
The rules that operate on these accounts in different countries vary (that is, some nations have minimum reserves others do not etc).
For financial stability, these reserve accounts always have to have positive balances at the end of each day, although during the day a particular bank might be in surplus or deficit, depending on the pattern of the cash inflows and outflows.
There is no reason to assume that these flows will exactly offset themselves for any particular bank at any particular time.
The central bank conducts "operations" to manage the liquidity in the banking system such that short-term interest rates match the official target - which defines the current monetary policy stance.
The central bank may: (a) Intervene into the interbank (overnight) money market to manage the daily supply of and demand for reserve funds; (b) buy certain financial assets at discounted rates from commercial banks; and (c) impose penal lending rates on banks who require urgent funds.
In practice, most of the liquidity management is achieved through (a).
That being said, central bank operations function to offset operating factors in the system by altering the composition of reserves, cash, and securities, and do not alter net financial assets of the non-government sectors.
Fiscal policy impacts on bank reserves - government spending (G) adds to reserves and taxes (T) drains them. So on any particular day, if G > T (a fiscal deficit) then reserves are rising overall.
Any particular bank might be short of reserves but overall the sum of the bank reserves are in excess.
It is in the commercial banks interests to try to eliminate any unneeded reserves each night given they usually earn a non-competitive return.
Surplus banks will try to loan their excess reserves on the Interbank market.
Some deficit banks will clearly be interested in these loans to shore up their position and avoid going to the discount window that the central bank offeres and which is more expensive.
The upshot, however, is that the competition between the surplus banks to shed their excess reserves drives the short-term interest rate down.
These transactions net to zero (a equal liability and asset are created each time) and so non-government banking system cannot by itself (conducting horizontal transactions between commercial banks - that is, borrowing and lending on the interbank market) eliminate a system-wide excess of reserves that the fiscal deficit created.
What is needed is a vertical transaction - that is, an interaction between the government and non-government sector. So bond sales can drain reserves by offering the banks an attractive interest-bearing security (government debt) which it can purchase to eliminate its excess reserves.
However, the vertical transaction just offers portfolio choice for the non-government sector rather than changing the holding of financial assets.
Option (a) "increases the assets that are held by the non-government sector $-for-$" is thus incorrect.
Option (c) "reduces the capacity of the private sector to borrow from banks because they use their deposits to buy the bonds" is clearly not correct.
This is based on the erroneous belief that the banks need deposits and reserves before they can lend. Mainstream macroeconomics wrongly asserts that banks only lend if they have prior reserves.
The illusion is that a bank is an institution that accepts deposits to build up reserves and then on-lends them at a margin to make money.
The conceptualisation suggests that if it doesn't have adequate reserves then it cannot lend. So the presupposition is that by adding to bank reserves, quantitative easing will help lending.
But this is a completely incorrect depiction of how banks operate.
Bank lending is not "reserve constrained".
Banks lend to any credit worthy customer they can find and then worry about their reserve positions afterwards.
If they are short of reserves (their reserve accounts have to be in positive balance each day and in some countries central banks require certain ratios to be maintained) then they borrow from each other in the interbank market or, ultimately, they will borrow from the central bank through the so-called discount window.
They are reluctant to use the latter facility because it carries a penalty (higher interest cost).
The point is that building bank reserves will not increase the bank's capacity to lend. Loans create deposits which generate reserves.
The following blog posts may be of further interest to you: