Academic journal article ABA Banking Journal

One Way to "Chum Up" Demand

Academic journal article ABA Banking Journal

One Way to "Chum Up" Demand

Article excerpt

Current weak economic growth is largely the result of inadequate aggregate demand for goods and services, not inadequate aggregate supply. A properly designed, Federal Reserve quantitative easing could "chum up" aggregate demand until banks can create adequate amounts of credit to get the job done.

I suggest the Fed target some specified rate of growth in combined Federal Reserve and bank credit--5% for instance. If banks on their own were not creating credit growth of 5%, the Fed could engage in some quantitative easing by purchasing securities such that combined Fed and bank credit grew at 5%. How could this increase aggregate demand for goods and services? Let's go through two scenarios.

In the first, let's assume the ultimate seller of the security to the Fed is a pension fund. The pension fund now has more cash and fewer interest-bearing securities. From where did the pension fund's extra cash come? The Fed created it "out of thin air." So, the Fed has created net new cash in the economy. Unless the pension fund desires to hold more cash and fewer securities, it will look for other securities to purchase to replace the ones it just sold. So, the fund will start bidding up the price (and consequently, down the yield), at the margin, of other securities. At the lower yield, the quantity of credit demanded by a household and/or a business will increase. …

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