When It Comes to Increasing Aggregate Demand, What's Fiscal Policy without Monetary Policy?
Not much. Suppose the central government decides to increase spending without increasing taxes. Where do the funds come from? From entities who are willing to lend. If those lending entities are the nonbank public, for the most part, all this does is transfer spending power to the central government from these entities. Net, net, total spending in the economy does not increase. Rather, there is just a change in the distribution of spending. Suppose, instead, that central and commercial banks are the lending entities. In this case, credit or spending power is created, not just transferred. That is, when the central and commercial banking systems finance increased government spending, the government is able to spend more without any other entity having to cut back on its spending. Thus, in order for an increase in government spending to result in an increase in total aggregate demand, the government spending needs to be financed by the central bank and the commercial banking systems.
What's been the record on this in the past year? In the four quarters ended Q1:2010, the cumulative increase in Treasury borrowing was $1,455 billion. During the same time period, the cumulative increase in Treasury security purchases by the Fed and U.S commercial banks (including fore was $419 billion, or about 29% of the total Treasury issuance. How does this 29% compare with historical percentages? From Q4:1952 through Q1:2010, the median percentage of combined Fed and commercial bank Treasury purchases to total Treasury issuance has been 15%; the average has been 213%. So, the recent "monetization" of Treasury debt has been above the median but well below the average. In sum, although the Fed and the banking system have helped fiscal policy to stimulate total aggregate demand, the help was not all that spectacular. No wonder the results of the recent fiscal stimulus program were something less than awe-inspiring with regard to increasing aggregate demand.
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Author: Paul Kasriel
Paul L. Kasriel
Director of Economic Research
The Northern Trust Company
Economic Research Department
Positive Economic Commentary
"The economics of what is, rather than what you might like it to be."
50 South LaSalle Street, Chicago, Illinois 60675
Paul joined the economic research unit of The Northern Trust Company in 1986 as Vice President and Economist, being named Senior Vice President and Director of Economic Research in 2000. His economic and interest rate forecasts are used both internally and by clients. The accuracy of the Economic Research Department's forecasts has consistently been highly-ranked in the Blue Chip survey of about 50 forecasters over the years. To that point, Paul received the prestigious 2006 Lawrence R. Klein Award for having the most accurate economic forecast among the Blue Chip survey participants for the years 2002 through 2005. The accuracy of Paul's 2008 economic forecast was ranked in the top five of The Wall Street Journal survey panel of economists. In January 2009, The Wall Street Journal and Forbes cited Paul as one of the few who identified early on the formation of the housing bubble and foresaw the economic and financial market havoc that would ensue after the bubble inevitably burst. Through written commentaries containing his straightforward and often nonconsensus analysis of economic and financial market issues, Paul has developed a loyal following in the financial community. The Northern's economic website was listed as one of the top ten most interesting by The Wall Street Journal. Paul is the co-author of a book entitled Seven Indicators That Move Markets.
Paul began his career as a research economist at the Federal Reserve Bank of Chicago. He has taught courses in finance at the DePaul University Kellstadt Graduate School of Business and at the Northwestern University Kellogg Graduate School of Management. Paul serves on the Economic Advisory Committee of the American Bankers Association.
The opinions expressed herein are those of the author and do not necessarily represent the views of The Northern Trust Company. The information herein is based on sources which The Northern Trust Company believes to be reliable, but we cannot warrant its accuracy or completeness. Such information is subject to change and is not intended to influence your investment decisions.
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