[OPE-L:2663] Re: Fed policy of accomodating federal debt issues?

From: Duncan K. Foley (foleyd@cepa.newschool.edu)
Date: Fri Mar 31 2000 - 23:15:02 EST

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Wallis' language is a bit idiosyncratic.

During the Depression and WWII the Fed adopted a policy of maintaining a
very low yield on long-term Federal debt (2.5%), by purchasing bonds when
they fell below the corresponding price. This policy effectively prevented
an "independent" monetary policy that could vary interest rates. It was
ended in the "Treasury-Federal Reserve Accord", which took place in 1951, I
think. This "Accord" was an agreement that the Fed could undertake an
independent monetary policy, which it did, in the sense that it no longer
maintained a rigid interest rate on Federal long term debt. It seems to me
that it was only under this policy that one could speak of a "monetization"
of the debt.

What Wallis seems to be referring to is the Volcker period in the late
1970s to early 1980s when the Fed responded to chronic and mildly
accelerating inflation with a very tight money policy that produced the
most severe post-WWII recession in 1980-82.


>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

Duncan K. Foley
Department of Economics
Graduate Faculty
New School University
65 Fifth Avenue
New York, NY 10003
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