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December 1984

Monetizing the Debt

Daniel L. Thornton reviews the meaning of the phrase “monetizing the debt.” He points out that today, as in the past, monetizing the debt means money growth—induced by rapid growth of the federal debt—in excess of that needed to achieve some monetary policy objective. Consequently, debt monetization cannot be analyzed independently of the objectives of Federal Reserve policy. He points out the inherent limitations of using such measures as growth of the Federal Reserve’s portfolio of government debt or growth in some reserve measure as evidence of debt monetization. He also shows how simple correlations between such measures and debt growth can give erroneous “evidence” about debt monetization. Finally, Thornton examines whether the Federal Reserve has monetized the debt in recent years by conducting tests of the temporal ordering of money growth and debt growth over the 1960-84 period. He finds no indication that the Federal Reserve has monetized the debt during the past decade, when the pressure to do so would seem to have been greater than it was in the 1960s and early 1970s.