Monetary and Fiscal Actions: A Test of Their Relative Importance in Economic Stabilization

This 1968 Federal Reserve Bank of St. Louis Review article by Leonall Andersen and Jerry Jordan — later known as the “St. Louis equation” — tests three commonly held propositions that fiscal actions have a larger, more predictable, and faster influence on economic activity than monetary actions, using reduced-form regressions of quarterly changes in GNP (1952:Q1-1968:Q2) on changes in the money stock or monetary base and on high-employment government expenditures and receipts. None of the three propositions is confirmed by the evidence: coefficients on money and the monetary base are consistently larger, more statistically reliable (higher t-values and partial coefficients of determination, ranging .38-.53 versus near-zero for expenditures), and no slower to appear than those on fiscal measures, while high-employment expenditure and tax-receipt coefficients are mostly small and statistically insignificant. In an illustrative simulation suggested by Milton Friedman, a $1 billion increase in government spending financed by borrowing or taxation raises GNP by only $170 million after four quarters, whereas an equal $1 billion increase in the money stock (holding the budget position fixed) raises GNP by $5.8 billion — and financing the same $1 billion spending increase entirely through money creation produces the identical $5.8 billion permanent GNP increase, which the authors attribute entirely to the monetary expansion. The paper explicitly frames these findings as “not proven true” in a strict scientific sense — only “not refuted” by the test period’s evidence — but argues they nonetheless support placing substantially greater reliance on monetary rather than fiscal actions for economic stabilization, including a set of GNP projections under alternative money-growth-rate assumptions for 1968-69.

Jerry L. Jordan | Macro Paper Warehouse

Monetary and Fiscal Actions: A Test of Their Relative Importance in Economic Stabilization