Fiscal Expansion #primers

The US Treasury issues Treasury debt at regularly scheduled Treasury auctions. The Treasury issued over $3 trillion in FY 2020. In essence, this means the Treasury spent over $6 trillion in fiscal year 2020 of which half was paid for by printing Treasury paper. The investors in Treasuries exchanged their bank deposits for Treasuries, but they simply swapped one form of money for another. The U.S. government spent those bank deposits on goods and services, so the total level of bank deposits in the banking system in unchanged. At the end of the day, the financial system has more ‘money’ in the form of Treasury securities.

This is fundamentally different from the Fed’s quantitative easing, which is more about changing the composition of the money in the financial system to lower longer dated interest rates. After QE, non-banks are forced to hold fewer Treasuries and more bank deposits but the quantity of money available to them is unchanged. (Yes, bank reserves are higher as well. Bank reserves can be freely spent, but in practice is only spent by banks on very safe assets because of the high regulatory costs of holding risky assets).

While there indeed is a lack of relationship between M2 and GDP, this is different for Treasury net issuance and GDP. M2 money can enter the financial system via the Fed’s printer converting Treasuries (not included in M2) to bank deposits (included in M2). But when the U.S. Treasury is printing money, it is essentially creating money (Treasuries) out of thin air and spending it on transactions that contribute to GDP such as defense goods and medical services. In fact, government spending is an explicit component in calculating GDP.

Government deficit spending directly boosts GDP.

#primers

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