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But inflation premiums in the interest on Federal debt should neither stimulate aggregate demand nor increase the demand for credit because they are simply compensation for a hidden tax-in the form of an expected reduction in the real value of Federal debt due to inflation. Although inflation premiums in interest on the Federal debt enter into the measured income of savers, they do not constitute an increase in permanent income that would boost consumption. All of the inflation premiums must be saved if the real value of Federal debt in private hands is not to decl i ne because of inflation. Only if the real value of this wealth is kept intact can income and consumption be maintained in real terms. In theory then, inflation premiums should be saved and would not stimulate consumer spending in the \Nay that other federal payments to the public do. Unfortunately, whetherthis is true in fact is an empirical question on which we currently have little information. the amount of loan activity observed. Nevertheless, the average subsidy element over all programs is substantial. According to estimates prepared by the Office of Management and Budget, federally-subsidized borrowers will pay an 8.7-percent average interest rate in fiscal 1981, but would have had to pay a 1 3-percent average rate without such subsidies. Federal and federally-assisted credit activities have thus reduced interest costs by one-third from what the private marketwould otherwise require. The net stimulus to private borrowing and aggregate demand depends upon the public's response to this amount of interest subsidy. We may assume that the percentage increase in loan demand equals the percentage reduction in the interest rate due to the subsidy. Consequently,' the net stimulus to private loan demand and spending equals one-third of the observed Federal and federally assisted loans omitted from the high-employment budget. Thus, we should add this stimulus to loan demand into the expenditures side of the budget to obtain a better measure of the Federal government's net impact on capital markets and aggregate spending. Similarly, in theory, any Government borrowing for the payment of inflation premiums is self-financing. If the Government must borrow to pay inflation premiums in the interest on its debt, holders of debt should save this income in order to maintain the real value of their wealth. Since this added saving is retu rned to the capital markets, Government borrowing to pay for inflation premiums is self-financing and therefore would not bid away loanable funds from private Consequently, to the extent that deficits are generated by borrowing to pay inflation premiums to holders of Government debt, there should be no crowding out. premiums The NI A high-employment budget not only omits a certain portion offederally-generated expenditures, but also includes other expenditures which should have no impact on either aggregate demand or the demand for credit. These payments consistofthe inflation premiums in the interest on Federal debt. Like other interest rates, nominal returns on government securities reflect 1) a real component not directly affected by the rate of inflation, and 2) an inflation component that incorporates both borrowers' and lenders' expectations of inflation. The higher the expected rate of inflation, the higher the rate of interest that borrowers are willing to pay and that lenders require to protect the purchasing power of their sacrifice in current consumption. In recent years, interest rates have risen with inflation, and higher interest costs thus have swollen the NI A high employment budget deficit. Thus, the impact of Federal budget expenditures on aggregate demand and credit demands is overstated by the amount of the inflation premiums in interest payments. The solution is either 'to subtract these inflation premiums from expenditures or add them to receipts. The former procedure would include in expenditures on/ythose items which truly add to the public's income as well as to demand in the credit market. The latter approach adds the receipts not already includ2
@FedFRASER