The Money Growth Component

In mine of the 10th I quoted Antal Fekete:

... the trend in marginal productivity of debt has been most definitely down. Once the zero bound is reached, any incremental increase in aggregate debt will have a detrimental impact on the economy.

I pointed out that the last sentence of the excerpt is based on the view that "rising total debt caused the downtrend in GDP growth", the view that I hold. I wrote: If adding to total debt produces a smaller increase in GDP than it formerly did, then harm has already been done.

Next, I evaluated Fekete's analysis of the graph he provides. I rejected his view that going off gold caused the decline of the marginal productivity of debt, and I ended with a series of four graphs offered to clarify my view -- the four graphs I've been repeating every morning for the last few days.

Let me say now, how these graphs are relevant to Fekete's post and to the productivity of debt. Perhaps that wasn't adequately clear in the post. Based on Fekete's text, his graph, and the trends I see in his graph, I summarize the history of "the marginal productivity of debt" as one long downtrend with an upward countertrend during the years 1986-2000.

The rate of growth of "Potential GDP" -- best-case growth -- follows a similar trend: one long downtrend, with an upward countertrend from 1992 to the year 2000 -- a downtrend that I attribute to the growth of debt, and a countertrend that I attribute to a significant reduction in debt growth.

The gap in the dates noted here, between the 1986 start of the debt productivity countertrend and the 1992 start of the countertrend in Potential GDP, the dates 1986-1992 identify the time of the significant reduction in debt growth.

To summarize, then: The downtrend in Potential GDP and the downtrend in debt productivity result from accumulating total debt and the cost imposed by that debt on the productive sector of the economy. The uptrend in Potential GDP and in debt productivity resulted in large part from a slowing of debt growth.

In addition to the slowing of debt growth, to achieve the uptrend it was necessary to have an increased growth of circulating money.


According to Fekete's graph and discussion, the marginal productivity of debt has been declining since the 1950s. I accept that, but point out a persistent and regular increase lasting near 15 years. My graphs attempt to explain this time of increase in debt productivity.

My graphs show a decrease in debt growth which begins in 1986 with the start of the increase in debt productivity. This decrease is closely followed by an increase in the growth rate of spending-money -- essentially a low-cost substitute for borrowed money. Together, slower debt growth and more rapid money growth create a shift in the Debt-per-Dollar ratio from 1990 to 1994. This down-shift in Debt-per-Dollar was the key, I claim, that boosted real and potential GDP growth, a boost which lasted to the 2001 recession.

The medium-term increase in marginal debt productivity that appears on Fekete's graph was created, in my view, by the fall in debt growth, and was supported by an unusually rapid growth of money in the early 1990s. Here are three views of that money growth:

Graph #1: The Growth of Total Debt (blue) and Spending-Money (red)

Graph #1 shows a large red spike in M1 money growth beginning just after the 1991 recession. The blue line, showing the growth of total debt, peaked in the mid-1980s and fell dramatically until just after the 1991 recession. No other red spike rises significantly above the blue (debt) line, until the crisis in 2008.

Graph #2: The Growth of Non-Federal Debt (blue) and Base Money (red)

Graph #2 shows a strong red "M" pattern following the 1991 recession, indicating significant growth of base money as compared to debt growth (shown in blue). Except for that "M", the red (base money growth) line is almost completely submerged below the blue (debt growth) line.

Graph #3: A History of Federal Debt Held by Federal Reserve Banks

Graph #3 shows the amount of Federal debt that has been monetized -- in other words, the Federal debt held by Federal Reserve banks. The blue line here represents an older data series, and the red line a newer series. Both are shown relative to GDP for context.

All through the inflationary 1970s, Federal Reserve holdings of Federal debt were falling as a percent of GDP. The early 1980s hump in money growth can be seen on this graph, beginning during the 1982 recession. The late 1980s hump is clearly visible. And the early 1990s hump in money growth rises to the mid-1990s, and never falls until the crisis.

The overview of this graph is interesting, I think: From start-of-data to 1981 the trend is down -- from 7% of GDP to 5%, to 6%, and finally to 4% of GDP -- due, I suppose, to a lot of inflation-fighting.

The trend since 1981 is up and up. One, two, three humps of increasing size; a fourth, even bigger hump in the 2000s, and a monster fifth hump after the crisis.

It might be interesting to compare debt-to-GDP numbers of 1960 to those of the latter 1990s. Both times the debt-held-by-the-Fed number was around 5% of GDP, but there was an astounding difference in total debt, and in non-Federal debt, relative to GDP and otherwise. For another post.

Anyway, the point of these three graphs is to show multiple views of rapid money growth in the early 1990s, which caused a shift in the Debt-per-Dollar ratio and, I argue, was a key part of the economic change that led to near a decade of better-than-average economic growth.

More tomorrow.