Re: Deficit Spending and Government Debt

On Tue, 16 Aug 2005 15:04:43 -0700, William F Hummel <wfhummel@xxxxxxxxxxx>
wrote:

> Deficit Spending and Government Debt
>
>Deficit spending means spending in excess of tax revenues.
>Essentially all of that spending must be recaptured to enable the Fed
>to control the inter-bank lending rate, i.e. the Fed funds rate. The
>Treasury normally does that by selling its own securities -- bills,
>notes, and bonds -- to the public.
>
>The Open Market Committee of the Federal Reserve sets the target for
>the funds rate. That rate establishes the upper limit on what banks
>must pay to borrow, and thereby determines the interest rate that
>banks charge on their loans.

William and I have a long-standing disagreement here that I am
obligated to record. The bank lending rate is determined by the
law of supply and demand -- what the buyer (borrower) is willing to
pay. The Open Market Committee looks at the state of this
supply and demand and *follows* it -- not *controls* it. As the
economy recovers, as it always has (with someone claiming
credit), the demand for money increases, the interest rate
rises and the Fed follows (proudly proclaiming: look, look,
I crowed and made the sun come up ! )

Having typed this, it must be typed that the Fed *can* reduce
interest rates by crashing the system as Volker did in the 1970's.
This is not the normal state of affairs. (and I suspect it would
have crashed anyway but Volker got to crow)

Mason C

> Bank lending rates directly affect the
>demand for loans and thus the amount of bank credit issued. That in
>turn determines the financial liquidity of the private sector. Too
>little liquidity will stunt investment and economic growth. Too much
>creates inflationary pressures that can cause other problems for the
>economy.
>
>It is evident then that maintaining a balanced reciprocal flow of
>funds between the Treasury and the private sector is an essential
>element in controlling the health of the economy. The question arises
>-- can the Treasury always sell its debt securities to cover its
>deficit spending? The answer is ?yes? as explained in the following
>scenario:
>
>Say the Treasury needs $10 billion by the end of the month to cover
>its deficit spending. It announces an auction for $10 billion of its
>securities to be sold at or before the end of the month. The auction
>participants, mainly large financial firms such as banks and
>securities dealers, bid competitively on a yield basis. That is, they
>state the yield and the dollar amount they will commit at that yield.
>
>There will always be a yield at which those with non-interest-earning
>dollars to spend will be willing to purchase interest-earning Treasury
>securities, and the Treasury can always meet whatever yield the market
>demands. The successful bidders are those who bid the lowest yields
>and whose combined bids total $10 billion. The highest yield among
>those bids sets the yield for the entire group. Bidders seeking a
>higher yield are rejected.
>
>It is worth noting that the Treasury need never default on its
>outstanding debt. It can always sell new debt to cover the maturing
>debt. That is true regardless of the total amount of Treasury debt
>outstanding.
>
>Another option, but almost never used, is for the Treasury to borrow
>directly from the Fed to cover its deficit spending. However that
>option would result in an uncontrolled increase of bank reserves. In
>order to maintain control of the Fed funds rate, the Fed itself would
>have to recapture the excess reserves. It would do so by selling
>Treasury securities from its own portfolio in an auction process
>similar to that described earlier.
>
>William F Hummel
>http://wfhummel.net/deficitspending.html

.

Relevant Pages

  • Deficit Spending and Government Debt
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  • Re: Deficit Spending and Government Debt
    ... > Deficit spending means spending in excess of tax revenues. ... > Treasury normally does that by selling its own securities -- bills, ... > state the yield and the dollar amount they will commit at that yield. ... money system is messed with by the Fed. ...
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  • Deficit Spending and Government Debt
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