3 ms·

Good explanation. Thank you. But isn't the demand for money going to go up because the US is running ginormous deficits? I would expect the demand for money to

by NTDF9 8y ago

Good explanation. Thank you. But isn't the demand for money going to go up because the US is running ginormous deficits? I would expect the demand for money to be through the roof.

tedsanders 8y ago
[Edited] As described by the IS-LM model, government deficits tend to do three things: -Increase output (more people working/getting paid) -Decrease economic investment (investors put dollars in treasuries instead of private sector projects) -Increase interest rates (fewer investor dollars to go toward private sector projects, since some have been diverted to government debt/production) However, the Fed usually tries to account for this force in their monetary policy (see monetary offset):https://www.bloomberg.com/opinion/articles/2018-07-20/fed-impact-on-deficit-has-nothing-to-do-with-trump https://www.bloomberg.com/opinion/articles/2018-07-20/fed-im...
- NTDF9 8y ago
  Doesn't debt issued by US treasury have to be funded by private holders of US dollars? Or does the Fed simply buy out the debt issued by treasury? I thought the Fed simply buys only a small portion of US treasury debt (thus printing money) but the vast majority of that treasury debt is purchased by holders of US dollars (banks, funds, China, Japan etc.)
  - tedsanders 8y ago
    Yes, debt issued by the US treasury is funded by private holders of US dollars. Here's how I think it works: -In theory, the Federal Reserve targets average inflation of 2% (along with its unemployment mandate) -When the US government runs a deficit, the government sells bonds and uses the dollars to pay whatever it's paying for -This process soaks up dollars from investors and gives out dollars to people, which on net lowers investment, increases interest rates, and increases GDP (see IS/LM model: https://en.wikipedia.org/wiki/IS–LM_model https://en.wikipedia.org/wiki/IS–LM_model) -The Fed, which aims to stabilize inflation, accommodates the rise in interest rates by setting higher target rates for its open market operations (if they fought the movement in interest rates by buying assets, inflation would rise, which is against their mandate)
    - RobertoG 8y ago
      How selling bonds soaks dollars from investors? If you go to a bank and ask for a credit for starting a business, if the bank approve of your project, they will credit your bank account with new money. That money is new created money. How is that related to more or less bonds sales?
      - tedsanders 8y ago
        If investors spend their dollars on government bonds, they have fewer dollars to spend on other investments. The lower supply of investor dollars for these investments causes interest rates to rise.

by NTDF9 8y ago

Good explanation. Thank you. But isn't the demand for money going to go up because the US is running ginormous deficits? I would expect the demand for money to be through the roof.

tedsanders 8y ago

[Edited] As described by the IS-LM model, government deficits tend to do three things: -Increase output (more people working/getting paid) -Decrease economic investment (investors put dollars in treasuries instead of private sector projects) -Increase interest rates (fewer investor dollars to go toward private sector projects, since some have been diverted to government debt/production) However, the Fed usually tries to account for this force in their monetary policy (see monetary offset):https://www.bloomberg.com/opinion/articles/2018-07-20/fed-impact-on-deficit-has-nothing-to-do-with-trump https://www.bloomberg.com/opinion/articles/2018-07-20/fed-im...

NTDF9 8y ago
Doesn't debt issued by US treasury have to be funded by private holders of US dollars? Or does the Fed simply buy out the debt issued by treasury? I thought the Fed simply buys only a small portion of US treasury debt (thus printing money) but the vast majority of that treasury debt is purchased by holders of US dollars (banks, funds, China, Japan etc.)
- tedsanders 8y ago
  Yes, debt issued by the US treasury is funded by private holders of US dollars. Here's how I think it works: -In theory, the Federal Reserve targets average inflation of 2% (along with its unemployment mandate) -When the US government runs a deficit, the government sells bonds and uses the dollars to pay whatever it's paying for -This process soaks up dollars from investors and gives out dollars to people, which on net lowers investment, increases interest rates, and increases GDP (see IS/LM model: https://en.wikipedia.org/wiki/IS–LM_model https://en.wikipedia.org/wiki/IS–LM_model) -The Fed, which aims to stabilize inflation, accommodates the rise in interest rates by setting higher target rates for its open market operations (if they fought the movement in interest rates by buying assets, inflation would rise, which is against their mandate)
  - RobertoG 8y ago
    How selling bonds soaks dollars from investors? If you go to a bank and ask for a credit for starting a business, if the bank approve of your project, they will credit your bank account with new money. That money is new created money. How is that related to more or less bonds sales?
    - tedsanders 8y ago
      If investors spend their dollars on government bonds, they have fewer dollars to spend on other investments. The lower supply of investor dollars for these investments causes interest rates to rise.