When government’s inflate the money supply (either through central banks or allowing banks to monetize their debt), does this “contribute” to the boom bust cycle? For example, many boom/busts in history have been proceeded by inflationary bouts due to wars. The Panic of 1819 was proceeded by the War of 1812/Panic of 1873 proceeded by the Civll War where the reckless banks inflated the money supply/# of banks to help the war effort; the Depression of 1921 was proceeded by the inception of the Federal Reserve, its lowering of R.R’s and inflating the money supply to pay for Federal expenditures (war effort).
Do these expansions of the money supply effect the business cycle at all when they are related to the war effort? If a war was going on during the early 1810’s, would the boom still have materialized, or would it have happened only after the war? (Giving it a four year window). Similar question to the Depression of 1921/ Panic of 1873.
If so, then how do we explain World War II, where our government heavily inflated the money supply and suffered no extreme boom bust cycle later on? Does expansions of the money supply when direcly used for government ependitures cause a boom bust, and can boom periods occur during this time frame?(How were the late 40s/50s btw?)
Hopefully people understand my question. Anyhow, thanks as usual.
Commercial banks are not allowed to monetize debt. Only the central bank (Federal Reserve) is allowed to print money to buy assets such as debt securities.
Inflating the money supply creates a supply of credit that enables investment to produce future goods that is not supported by individual’s demand for future goods. An individual demands more future goods if they consume less and save more today. Less consumption today will free up commodities that can be used to produce more future goods. Expansion of credit therefore creates errors in the economic calculations by entrepreneurs and therefore it promotes distortion in the economy. This results in malinvestment and must later be corrected by bankrupcy or business failure. When the expansion of credit is excessive and prolonged then such easy money can fuel a boom. The malinvestment and speculation that occurs during the boom must end in a bust.
During the war’s, typically the money is printed (money supply expanded) to swindle the wealth from the citizens to direct it towards the creation of bombs, jeeps, planes, food & clothes & shelter for the soldiers. It’s just another form of taxation on the people. Commodities and supplies would be reserved for the more important utility of war needs. I don’t imagine in the face of rising commodity prices and reduced supplies for civilian use does this create much boom for businesses - other than businesses building the planes & jeeps. As for distortion? When the war is over you don’t need to produce war machines at levels required during time of war so there will be a recession / mini depression to liquidate the factories to convert them to producing products for domestic use.
I believe after WWII there was a recession to redirect the economy to produce more consumer goods and less war machines. During the war, everyone at home had jobs & worked to create war machines, to export food to feed Europe, and were essentially forced to save their money because of lack of consumer goods available for purchase. They saved their money and paid down personal debt that remained after the great depression. After the war, the surplus of available labor with savings in hand to afford consumption created immediate real demand for a real boom in consumer goods.
I don’t imagine that US civilians during WWI or WWII had it nearly as prosperous as they had it during the last 8 years while the USA borrowed & printed money to fund its wars in Afganistan and Iraq.
What do you mean? Fractional Reserve banking does exactly that: monetize debt.
Fractional Reserve banks create bank credit out of thin air - which creates debt out thin air. I guess you can think of this as money created that is backed by someone else’s promise to pay. But debt created new money. Money wasn’t created for the purpose to buy debt.
When I think of monetizing debt I think of directly creating new money out of thin air to buy debt securities (assets) already in existence, like say issued US gov’t bonds. Existing debt that is already someone else’s promise to pay. Like say a mortgage that has been borrowed and the builder has received the bank’s check money and the borrower promises to produce the equivalent in the economy to earn the money equivalent to pay back the bank. But then the borrower looses his job and defaults. This puts a hole on the bank’s balance sheet. The Fed comes along and creates new money to buy the mortgage (considered an asset) from the bank to make the bank whole. Now the Fed has the bad mortgage on its balance sheet while the bank’s reserve account at the Fed just increased by an amount equivalent to the mortgage. The Fed expanded the money supply by the size of the mortgage - which doesn’t go away. The bank can now create / leverage fractional credit off this new reserve created by the Fed. Once the bank has its reserve fully loaned out it can’t expand the money supply anymore. But when the Fed buys a mortgage asset off a bank (with new money) then that new money ends up in the bank’s account with the Fed which enables the bank to expand credit further.
I am not sure about your terminology. I would say that to monetize debt, simply means lending out money that was created out of thin air instead of coming from real savings.
I think monetizing debt is exactly what commercial banks are doing. Just like the Fed creates money to buy IOUs such as government securities, so do commerical banks create money to buy IOUs. In fact commerical banks do also buy government securities using their leverage of fractional reserve banking.
If you google search “debt monetization” all the answers suggest:
Debt monetization
Debt monetization occurs when a nation’s central bank (e.g. the Federal Reserve in the United States) buys government bonds. [1] If a government’s expenses exceed its tax revenue, if nothing is done the government will draw resources (capital) out of the private market. Since there is a limited amount of capital available in the market, there will be less available to fund business growth if the government takes out a substantial portion. If the debt is monetized, the capital is thereby returned to the private market.
Debt monetization can be seen as a flat tax because the ultimate result is that the government acquires additional funds and the currency decreases in value.[citation needed] However, monetization helps the government temporarily to meet its short term commitments at the beginning.[citation needed] Debt monetization has the drawback of increasing the twin deficit. That is, when government financing is increased, along with interest rates and foreign capital, the trade deficit also goes up along with the budget deficit.[citation needed]
Today, as in the immediate post-World War II period,
the phrase “monetizing the debt” means money
growth induced by attempts to moder’ate the effects of
rapidly growing gover-nment debt on interest rates.
To simplify the terms, monetization amounts to nothing more than printing money. It works the following manner: when the federal government can’t seem to find domestic or foreign buyers for its debt issue, usually because the interest rate is not high enough to attract lenders – a particularly acute dilemma in a low-interest-rate environment, the Federal Reserve Bank buys this debt and issues a check to the government. The government spends this money and in turn debases all the currency outstanding.
I don’t think the Federal Reserve normally buys debt directly from the Treasury, they usually buy old bonds from commericial banks who now have more money to buy new bonds from the Treasury. Thats the common way I’ve read it, and thats the way Rothbard described it in Mystery of Banking.