Stagflation and Financial Instability
In the preceding chapter we analyzed how the postwar monetary regime contributed to an unprecedented economic boom during the 1950s and 1960s. Its institutional provision of continuous credit extension and automatic "monetization" of debt helped to finance various channels for spending in excess of current income. The most important sources of excess spending were depreciation charges on industrial capital, consumer purchases of large-ticket items, regular budget deficits, and America's seigniorage benefit. The resulting stimulation on the demand side combined with monopolistic price regulation on the supply side to support real wage growth in line with productivity gains. This combination relaxed the monetary constraint in the production economy, as illustrated by the ability of firms to avoid deflationary price adjustments and to turn the devaluation of their plant and equipment into a source of cash flow.
The stable growth pattern of the postwar boom was very much contingent on increasing debt and regular liquidity injections via endogenous money creation. This debt economy had its roots in the Great Depression, a deflationary crisis which prompted massive debt reduction and monetary reforms toward elastic currency. During World War II, a period of rapid income growth and forced savings, both U.S. consumers and industrial firms further strengthened their balance sheets. Once the war ended, they were therefore in a good position to take on significantly more debt. At the same time, U.S. budget deficits fell from their exceptionally high levels of the war period, thus creating space for more rapid credit extension to the private sector. While the level of total debt in the United States rose in line with the gross national product during the postwar boom, its composition shifted quite dramatically from public debt to private debt. This remarkable long-run stability in the ratio of total debt to GNP illustrates the essentially self-financing nature of the "debt economy," with debtors creating sufficient income gains to