Evaluating credit as a tool to boost aggregate demand

You've seen the GDP equation Y = C + I + G + NX where

• C = Consumer spending
• I = Business Investment
• G = Government spending, and
• NX = Net Exports

C and I and G represent the three major domestic sectors of the economy, and NX covers trade with other nations.

Okay, I want to look at interest cost, not GDP. But I want to look at interest cost in our whole economy. So again there are the three major domestic sectors. In place of Net Exports we could have interest paid by "rest of the world" but I don't want to count that: I want to count the interest paid by us -- by US households and businesses and governments. And I want to count that interest, no matter who received the payment. So I have C and I and G but I don't need Net Exports.

To count all of G it is necessary to count two parts: the federal component, and the state-and-local component. So to count all interest cost, I count interest paid by C + I + F + SL.

I could use FRED's "Monetary Interest Paid" dataset, but that only goes back to 1960. C and I and SL go back to 1946, and F goes back to 1929. Evidently, FRED doesn't combine those datasets, probably because they are incompatible.

I'm going to combine them anyway, to get a rough idea of what the interest cost might have looked like all the way back to 1946.

Here is the combined data:

Graph #1: The orange data continues out to 2020. This graph stops at 1975.

The blue line is my estimate of interest paid during the 1946-1959 period. It includes payments by households, businesses, the federal government, and state and local governments.

The orange line begins in 1960 and shows the FRED data for the total Monetary Interest Paid.

That was more work than I expected, considering the simple thing I want to do with the resulting data: I just want to compare the cost of interest to the new use of credit each year.

I'm thinking of new-use-of-credit as extra money spent into the economy. And I'm thinking of cost-of-interest as a reduction of money available for current spending. I think the "extra money" will have to be greater than the "reduction of money", or the economy will get no boost from the use of credit.

 

My purpose in this post is to evaluate the flow of credit into the economy, and the flow of payment-for-that-credit out of the economy, or (more precisely) out of the producing-and-consuming sector and into the financial accumulation sector. My task is an attempt to see how useful credit is as a tool for expanding aggregate demand in the producing-and-consuming sector. 

My gut says it is no longer useful, because the accumulation of debt is so big that the interest we pay -- even at low rates -- is more than our new uses of credit. I figure it is the financial accumulation sector that benefits most by our use of credit.

The graph below shows for each year the total amount borrowed by all sectors of the US economy, minus the amount we paid as interest on our debt. Where the plotted line is above zero, it shows a boost to the economy from our borrowing and spending. Where the line is below zero, it indicates a drag on the economy arising from interest costs that exceed the amount of our borrowing. Where the line is at zero, there is no boost and no drag. Note: The values shown on the graph are annual, not cumulative:

Graph #2: That tall spike on the right is the covid-related borrowing of 2020

Until around 1978, the plotted line runs near zero. It says there was no net gain from our use of credit, but no net loss either.

After 1978 the plotted line is almost entirely below zero. Net loss almost all the time, except in the financial accumulation sector. This could explain the relatively poor performance of our economy for the last 40 years and more.

Below is a close-up of the early years, from 1946 to 1982:

Graph #3

It runs at or slightly above the zero level until around 1966; then at or increasingly below the zero level. In other words, there was a very slight boost to the economy from credit use, early on. But after 1966 the use of credit did more harm than good, as the interest cost was generally more than the boost we got from credit use.

That drag on the economy continued after 1982, as graph #2 shows. That graph can explain the slowing of the US economy since 1966. Thus one argument -- the growth of finance -- explains the long-term slowing of economic growth.

 

The Excel file at DropBox: Monetary Interest Paid datasets 3 Jan 2022 ArtS.xls