Sunday, April 12, 2015

Macroeconomic Stimulus Leaves a Remainder

Modern macroeconomic stimulus attempts to increase the amount of money flowing through the macro economy. The basic approach is to lower interest rates to encourage increased borrowing. An increase in borrowing results in more monetary transactions which translate into the exchange of more goods and services.

The increased borrowing comes from mostly from banks. The banks can be private commercial banks or a national central bank (usually government owned). 

New borrowing is accompanied by a loan document signed by the borrower. Modern banking in the United States does a good job of reporting the level of bank lending, which allows the investigating economist a window into how much new money is injected into the economy on an annual basis.

Banking theory would hold that newly borrowed money remains in an economy until the loan is repaid. Unlike individuals who borrow money and then spend it, leaving an empty wallet, the macro economy circulates borrowed money until it disappears into loan repayment. (For example, a 30 year loan will have a declining portion of the original loaned money continue to circulate for the full 30 years.) 

When we go looking for money circulating from government and private borrowing, we cannot find that money as either currency or deposits. Part of the money has disappeared into the form of government bonds which are not counted as money. This disappearance is the result of efforts by government to control the rate of spending and thereby the value of the money. Money is moved to the sidelines by government borrowing, 

Yet, government does spend the borrowed money, and thereby does recycle the original money. More money movement, less actual money needed. The amount of money moved is recorded in the loan documents.

Our goal is to learn how much stimulation (new money) has flowed into the United States economy in recent years. If MMT and Keynesian monetary theory is correct, the new money should have expanded the economy measured by GDP. The amount of new money injected should be recorded as increased debt. We should be able to look at the increase in bank loans and the increase in government debt, and then trace this increase as money that has flowed into the macro economy. This increase should increase the GDP on a dollar for dollar basis (at least), and should increase it more than that due to re-spending by the economic players.

Any stimulation should not only increase GDP, it should increase the taxes extracted by government. A pattern of stimulation, followed by increased tax revenues which generate partial stimulation recovery, would occur in every annual period. We could write this mathematically to say

       stimulation = remainder + change in tax revenue

where the term remainder is the amount of stimulus that remains in the economy at the end of the measuring period.

We could find the amount of 'remainder' from adding the annual government deficit and the annual change in total bank loans outstanding. The term 'change in tax revenue' could be found from the annual GDP change multiplied by the average tax rate.

Figure 1. illustrates the annual stimulation that has occurred in the United States beginning in 1948. It is a far larger number than the (about) four percent annual inflation that has occurred in price levels. The chart can be found online at the Federal Reserve Data Website.

Figure 1. Annual United States stimulation from bank loans and government deficits, expressed as a ratio to GDP. Possible stimulation from corporate or government sponsored residential loan activity is not included.
The actual amount of annual United States stimulation could be larger than shown in Figure 1. Mechanisms such as "Fanny Mae" and "Freddie Mac" purchase loans from private banks, thereby taking loans off the private books. No attempt to quantify this data deficiency was made for this post but it could be a large amount.

This effort to quantify annual stimulation is subject to a large amount of data 'noise'. For example, GDP is a calculated estimate (done with considerable care) but the estimate is dependent upon sketchy data. The distorting effect of bank loan sales has already be mentioned. Other distortions (such as corporate bonds) and data deficiencies may exist.

We can look for distortions in Figure 1. The declining stimulus from the early 1990's to 2000 is a particularly good example. This period contained the 'dot com' boom which collapsed about year 2001. Corporate borrowing and massive new issues of stock accompanied the boom. Government tax revenues would have increased, reducing the 'need' for government deficits. Indeed, government tax revenues exceed expenses for part of the period between 1998 and 2001.  All of these observations argue for the need to expand the observed data sets that would describe the term 'remainder'.


Figure 1 demonstrates about 67 years of continuous economic stimulation. The rate of stimulation has varied from less than 2 percent to more than 10 percent of GDP annually.

No attempt has been made to relate interest rates to the rate of stimulus. A comparison may be the subject of a future post.

No attempt has been made to compare stimulation with employment levels. Any effort along this line of investigation should await a better analysis of which data is best used to quantify the term 'remainder'.

The lines between investment, 'new money', and borrowing are not as clear as macro-economist would prefer. For example, corporate bond or stock sales may not be to banks but may result in economic stimulation. For purposes of Figure 1, any financial activity that resulted in both economic stimulation and a stimulation remainder should be counted as part of the term 'remainder'.

The contribution to stimulus recovered by taxation should be independent of the 'remainder' term but may be related in a common (not yet determined) ratio.

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