Modern Macroeconomics.pdf

506 Modern macroeconomicsmuch as short-term rates may mitigate – but cannot eliminate – the generaleffects of the credit expansion. Further, these general effects are independentof which particular policy tool the Federal Reserve employs. Credit expansionsbrought about by a reduction in the discount rate (now called theprimary credit rate) or by a reduction in reserve requirements could besimilarly described. All of the institutionally distinct monetary tools aremacroeconomically equivalent: they are all means of lending money intoexistence and hence have their initial effect on interest rates.For comparison, the central bank’s augmentation of credit depicted inFigure 9.10 is set to match the actual shift in the supply of saving depicted inFigure 9.8. Rather than create a new equilibrium interest rate and a correspondingequality of saving and investment as was the case in a saving-inducedexpansion, the credit expansion creates a double disequilibrium at a subnaturalinterest rate. Savers save less, while borrowers borrow more. Notethat if this low interest rate were created by the imposition of an interest rateceiling, the situation would be different. With a legislated ceiling, borrowingwould be saving-constrained. The horizontal distance at the ceiling rate betweensupply and demand would represent a frustrated demand for credit. Acredit shortage would be immediately apparent and would persist as long asthe credit ceiling was enforced.Credit expansion papers over the credit shortage that would otherwiseexist. The horizontal distance between supply (of saving) and demand (forcredit) is not frustrated demand but rather demand accommodated by thecentral bank’s injections of new credit. It represents borrowing – and henceinvestment – that is not accommodated by genuine saving. In the final analysis,of course, real investment cannot be in excess of real unconsumed output.To say that credit expansion papers over the shortage is not to say that iteliminates the problem of a discrepancy between saving and investment. Itonly conceals the problem – and conceals it only temporarily. In summaryterms we see that padding the supply of loanable funds with newly createdmoney drives a wedge between saving and investment. The immediate effectof this padding is (i) no credit shortage, (ii) an economic boom in which the(concealed) problem inherent is a mismatch between saving and investmentfesters, and (iii) a bust, which is the eventual but inevitable resolution to theproblem. (With this summary reckoning, however, we have got ahead of thestory.)The double disequilibrium in the loanable funds market has as its counterpartthe two limiting points on the production possibilities frontier. Savingless means consuming more. But with a falsified interest rate, consumers andinvestors are engaged in a tug-of-war. If, given the low rate or return onsavings, the choices of consumers were to carry the day, the economy wouldmove counterclockwise along the frontier to the consumers’ limiting point.