[OPE-L:2645] Fed policy of accomodating federal debt issues?

From: Rakesh Bhandari (bhandari@Princeton.EDU)
Date: Thu Mar 30 2000 - 09:28:19 EST

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If any of you monetary economists out there have a spare moment, would you
kindly consider responding to this request. I am just finishing a paper on
Mattick Sr's theory of the limits of the mixed economy, and I wanted to be
absolutely clear about the following policy.

Thank you in advance. Of course feel free to respond off list.

The economist Wallis refers to the abandonment of the Federal
Reserve Bank's policy of accomodating federal debt issues in the late
1970s. Would someone kindly tell me what that policy was and how it
worked exactly? Is this a reference to the monetization of the federal
govt's debt--and how did that work? The rudiments are fine or any
reading recommendation would be appreciated.

I must say that Wallis' argument confuses me--how could have a massive
increase in military expenditures been part of ending war time finance? At
any rate, that's not my question.

Thanks, Rakesh

John Joseph Wallis, "American Government Finance in the Long Run:
1790-1990" Journal of Economic Perspectives vol 14, no 1 Winter 2000, pp.

"For 35 years after 1945, national military expenditures were
extaordinarily high and national interest payments were extraordinarily
low. The postwar pattern only makes sense if we think of World War II as
the beginning of a lengthy shock called the Cold War that would take 40
years to run its course. From 1940 to 1980, the nation experienced what
amounted to wartime mobilization in fiscal policy, combined with wartime
monetary accomodation to help keep interest rates low. Monetary
accomodation produced inflationary pressures, culminating in the great
inflation of the late 1960s and 1970s. Real interest rates remained very
low into the late 1970s, when the Fed finally abandoned its policy of
accomodating federal debt issues.

"The national debt crisis of the 1980s and 1990s is much easier to
understand in light of this history. In a long-term perspective, a
reasonable fiscal plan might have been to end Cold War defense
expenditures first, then reduce taxes, and finally go back to a more
sustainable monetary policy. Intead, the first step toward the end of
wartime finance was the Federal Reserve Board's decision to top
accomodating national government debt issues in the late 1970s. This
slowed inflation and sharply raised real and nominal interest rates. The
next move, in the early 1980s, was to lower tax rates and increase
military expenditures. National tax revenues fell from 19.7 of GNP in
fiscal 1981 to 17.5 percent in 1983, while outlays rose from 22.3 percent
in 1981 to 23.6 0n 1983. Military expenditures remained high until the
late 1980s. The short-term deficits had to be financed at the highest
nominal interest rates in the nation's hisotry and the highest real rates
since the end of World War I. Between 1981 and 1993, natinal debt held by
the public grew from 25.8 percent of GNP to 50.1 of GNP. The end of
wartime finance finally came with the reduciton in military expenditures
at the end of the 1980s, when military expenditures dropped from 6 percent
or more of GNP in the mid-1980s to about 3 percent of GNP by late 1990s.
The peace dividend eventually experienced in the 1990s ended up being
roughly equal to annual interest on the national debt."

pp. 77-8

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