Anatomy of a Market MeltdownRoger W. Garrison

Auburn University

Federal Government Surplus (+) and Deficit (-) in billions of dollars (1994 to present)

Federal Reserve Economic Data

The federal budget deficit is expected to reach $500 billion or more by next year.

Federal Reserve Economic Data

Will the Bush 43 deficit of 2004 be worse than the Bush 41 deficit of 1992?

Federal Government Surplus (+) and Deficit (-) in billions of dollars (1925 to present)

$293 billion

$500 billion

Compare deficit-to-GDP:

1992: 293 / 6,184 = 4.7%

2004: 500 / 11,200 = 4.5%

Compare deficit-to-saving:

1992: 293 / 1,018 = 28.8%

2004: 500 / 1,400 = 35.7%

Federal Government Surplus (+) and Deficit (-) in billions of dollars (1925 to present)

$293 billion

$500 billion

Why can’t we do in 2003 what we did in 1992?

?

Federal Reserve Economic Data

4%1%

Federal Funds Rate (1959 to present)

How many arrows are left in Greenspan’s quiver?

Federal Reserve Economic Data

1%

Federal Funds Rate (1994 to present)

1%

Federal funds rate target: 1% since June 2003

Federal Reserve Economic Data

Discount Rate (1994 to 2003)

0.75%

The discount rate was lowered to 0.75% in late 2002.

primary credit rate = 2.25%

Federal Reserve Economic Data

Primary Credit Rate (2003 to present)

The Fed now has the primary credit rate above the fed-funds rate instead of a discount rate below it.

Federal Reserve Economic Data

M1 Money Stock (1959 to present)

Should the Fed return to money-growth targeting?

Federal Reserve Economic Data

Federal Reserve Economic Data

Operating ratios are much less predictable than in the heyday of monetarism.

Currency Component of M1 (1947 to present)

There has been a dramatic rise in the currency ratio (C/M1) during the last 10 years:

1993: C/M1 = 28.5%

2003: C/M1 = 50.7%

1960 1970 1980 1990 2000

INC

OM

E V

EL

OC

ITY

OF

MO

NE

Y

“T R E N D” I N V E L O C I T Y

Adapted from Brad DeLong’s “Triumph of Monetarism?” Journal of Economic Perspectives, Winter 2000

pre-1980’s trend in velocity

actual velocity of M1

Heyda

y of

mon

etar

ism

0

2

4

6

8

10

1 17 33 49 65 81 97 113 129 145 161 1771960 1970 1980 1990 2000

pre-1980’s trend in velocity

“T R E N D” I N V E L O C I T Y

Federal Reserve Economic Data

Gross Saving (private and corporate) in billions of dollars (1994 to present)

The D/S ratio measures the extent to which the government is a Big Player in credit markets.

Likely movement in the deficit-to-saving ratio:

D/S = 35.7%

FISCAL STATEGISTS ARE CONFRONTED WITH A

SHORT LIST OF BAD OPTIONS

BORROW DOMESTICALLY

MONETIZE DEBT

BORROW ABROAD

RAISE TAXES

CONTINUE DEBATING

High interest rates

Inflation (with leverage)

Weak export markets

Dampened market activity

Market uncertainties

Gross Federal Debt in billions of dollars (1939 to present)

Which way is the government’s debt headed?

Federal Reserve Economic Data

Anatomy of a Market MeltdownRoger W. Garrison

Auburn University