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How Money Finds its Way Into the Economy

President Obama’s stimulus bill is a reminder of how creative our government can be when injecting cash into our economy. However, many are not aware of exactly how and where the money comes and goes. The government does not simply dump billions of dollars into the system and inflation and deflation are some magical by-products — in reality, money is distributed to specific groups at specific times for specific reasons. Today we will examine some of the basic ways that our government puts money into the economy, including some specifics of the recent stimulus package.

The Federal Reserve

Ryan McFarland

It all starts with the Federal Reserve, the “central bank” that literally puts money into circulation at our financial institutions. The banks we use day-to-day (like Bank of America, Wells Fargo, and People’s), may borrow from other banks, but ultimately they borrow from the Federal Reserve – known as simply “the Fed” for short – once it is printed by the US Treasury. As a quasi-public institution, the fed is charged with regulating the nation’s money supply through its setting of monetary policy. Primarily, this consists of setting the interest rates at which banks lend money to other banks, which greatly influences how much money pervades the economy at any given time. When these inter-bank lending rates are too low, many argue, money becomes too easily available and creates economic bubbles.

The Fed reports data on the nation’s money supply weekly and monthly in the form of M1 and M2. M1 is a measure of actual, physical currency, consisting of, “…currency in the hands of the public, travelers checks, demand deposits, and other deposits against which checks can be written” according to the New York Federal Reserve Bank website. This includes currency held by foreigners, as this can, in theory, be spent on US goods. In April 2008, for example, M1 was clocked at $1.4 trillion. M2 consists of everything in M1, “…plus savings accounts, time deposits of under $100,000, and balances in retail money market mutual funds.” M2 was clocked at $7.7 trillion in that same period, the difference consisting largely of savings deposits. The fed typically reports both M1 and M2 data every Thursday at 4:30PM, and you can find the latest stats in Friday business papers like the Wall Street Journal.

The Internal Revenue Service

Calistan

Outside of physically distributing money, the other main way the government puts money into the economy is by first taking it out of the economy. Before money can be dispersed to particular groups via subsidies, welfare payments, or payments in kind (such as free or subsidized housing), it must be collected from those originally in possession of that money. This is done primarily via income taxation, which represented 44% of all collected taxes in 2006, but also through a number of other taxes including: corporate income tax, gift taxes, employment taxes, excise taxes, and estate taxes. Capital gains (investment income) are taxed as well. In total, it is estimated that the IRS took in $2,518,680,000,000 in taxes during fiscal 2006 according to the Heritage Foundation.

A breakdown of which taxes contributed most to this figure can be found here.

Once collected from taxpayers, this money is then distributed by government to various groups and agencies through vehicles described below.

Subsidies

MVI

One of the most common ways government puts money into the economy is through the distribution of subsidies. Any business or industry receiving payments from the government is said to have been subsidized. An oft-cited example is agricultural subsidies, which the government pays to various farmers and corporations deemed (at least ostensibly) to be vital to America’s food supply. A Washington Post investigation into farm subsidies reveals that while most subsidy payments go to farmers growing important crops, as much as $1.6 billion has gone to farmers who grow nothing at all but receive checks anyway due to neglect and systemic fraud. For our purposes, however, we need only know that such subsidies are paid to businesses and industries whose survival is politically important.

Another form of subsidy involves payments in kind, such as subsidized housing. In this case, low-income families are provided with housing paid mostly or in full by the government – that is, taxpayers. The construction and maintenance of subsidized housing puts money into the pockets of contractors, developers, and utilities as well.

Government Contracts

Qwrrty

While the government at federal, state, and local levels is responsible for everything from building roads to building schools, government officials do not literally build any of these things. Instead, private firms and individuals are hired to do the work through government bids and contracts. When a town needs a new school or playground, for instance, local contractors and construction companies will typically submit bids of how much they would charge to do the job. The government then selects the winning bid and pays the winner an agreed-upon amount, which then gets spread around to materials distributor, the salaries of those working on the job, and the contractor’s profit.

Government contracts are so potentially lucrative that a website – Business.gov – was established to direct businesses on how to go about submitting bids for them. Between construction, administrative processing and defense, hundreds of billions of dollars are awarded by government contracts every year.

Stimulus Spending

Zleak

During economic disasters, the federal government typically attempts to “stimulate” the economy by allocating money to sectors or industries in trouble. Perhaps the most famous example of government stimulus spending is the New Deal, enacted by President Franklin Delano Roosevelt between 1933-1935 to offset the crises caused by the Great Depression. The agricultural subsidies discussed earlier actually originated during this time, as farming was hit exceptionally hard by the Depression. In addition, the New Deal sought to right a sinking ship by instituting public works projects. Roosevelt’s Public Works Administration spent some $3.3 billion in taxpayer money paying private companies to build 34,599 projects ranging from dam construction to bridge building, according to Jason Scott Smith’s Building New Deal Liberalism: The Political Economy of Public Works.

A comparable effort to the New Deal is President Barack Obama’s $787 billion Recovery and Reinvestment Act of 2009. The industry deemed most troubled today (as opposed to farming in the 1930′s) is the automotive industry. In order to drive sales in this beleaguered sector, Obama instituted the Cash For Clunkersprogram, which pays individuals $3,500-$4,500 (depending on how fuel-efficient their current vehicle is) to buy a more fuel-efficient vehicle. The program’s website states that Cash For Clunkers is slated to run from July-November 2009 (although this is probably unlikely), and pay over $2 billion to car buyers and that over 250,000 cars have been sold so far, though Edmunds.com notes that interest is reportedly dying down.

MSNBC notes that the stimulus includes a $50 billion “rescue fund” to prevent homeowners from losing their homes to foreclosure. Presumably, these funds are dispersed to the lenders in position to foreclose so that they will not exercise that option.

The stimulus also pumps $40 billion more into expanding payments to the unemployed, $19 billion to food stamps, $3.95 billion for job training, and $125 million for “subsidized community service jobs for older Americans”, according to Wikipedia.

Additionally, some $27.5 billion has been allocated for road and bridge construction, as well as $6.9 billion for public transportation. All of these programs represent money being placed into the hands of various individuals and groups by the government.

So, as we have seen, the ways in which government puts money into the economy are virtually endless. They grow in number every year, and vary according to which way the political winds happen to be blowing at a given time.