Tag: relationship between deficits and inflation

–Debt “unsustainable” no longer.

An alternative to popular faith

        Just when I thought the Chicago Tribune was starting to get it, they ruined everything. For years, the Tribune has told its readers the federal deficits and debt are unsustainable, that China and the other nations would refuse to lend to us, that the government would be unable to service its debts and that federal taxes needed to be increased or spending reduced.
        And because the federal debt is unsustainable, the government is not able to support Medicare, Social Security, Medicaid and universal health care without significant tax increases or benefit cuts.
        Then I saw this in the March 30, 2010 editorial titled, “Debt Dangers”:“But the U.S. is not about to run out of money, even if it keeps overspending. Why not? First it can appropriate more of its citizens earnings through the tax system. Second and most important, it can print money to pay its bills.”
        Wow, is the staid, old Tribune finally starting to understand? Do they realize the government can support Medicare, Social Security, Medicaid and universal health care, even if taxes are reduced? Do they understand we don’t need China and the other nations to lend to us, because we can create money without borrowing?
         Sadly we were not to be so fortunate, for a few sentences later, the editorial said, “The danger is that (the government) would create money to make those debts payable, a course that would lead to much higher inflation.”
        Never mind that today, following the most massive deficits in our history, the government’s chief worry is deflation, not inflation. Never mind that for the past forty years, there has been zero relationship between deficits and inflation, and in fact, the largest deficits have corresponded with inflation reductions. (See the graph, below).

Debt vs inflation

        And never mind that deficits repeatedly have proved stimulative, while reduced deficits are depressive. Intuition and popular faith trump facts every time.
        Then the Tribune editors compounded the crime by stating, “The economy would also suffer as businesses and households scrambled to cope with the disruptive effects of soaring prices. It would suffer again if and when the government decided to curb inflation by driving up interest rates — a step that virtually guarantees a sharp downturn.”
        Never mind that high interest rates have not slowed GDP, nor have low rates stimulated, which is why the Fed’s twenty rate cuts failed to prevent or cure the recession. (See the next graph. If high interest rates slowed GDP, the peaks of the blue line would have to correspond with the troughs of the red line.)

InterestratesvsGDP

         But at least, the Tribune has taken the first step, and perhaps we never again shall see that ridiculous sentence, “The federal debt is unsustainable.”

Rodger Malcolm Mitchell
http://www.rodgermitchell.com

–Another attempt to explain the positive effect of deficits

An alternative to popular faith

I’m searching for a way to explain that contrary to intuition and to what the media and politicians say, large federal deficits are good, not bad. Please read this and tell me whether you believe its clear enough for non economists.

The federal government is unique, far different from you, me, businesses and local governments. Its finances, particularly its deficits may seem counter-intuitive. You may have three fundamental questions about federal deficits:

1. Are large deficits unsustainable? Is there a time when the government will not be able to service its debts?

2. Do large deficits have an adverse effect on the economy?

3. Are large deficits beneficial?

Unsustainable: Visualize a scenario where there are zero federal taxes. The federal government has no income, yet sends you, “Mr. Lucky,” a check for $10 trillion dollars. You will deposit the check in your bank.

Will the check bounce? No. Your bank will credit your account for $10 trillion, then send the check to the Treasury, which will credit your bank and debit its own balance sheets for $10 trillion. You now have $10 trillion in your account, allowing you to buy a few thousand Rolls Royces or the State of Montana, whichever you prefer.

The government can debit its balance sheet and credit your bank, endlessly. The balance sheet is just a score sheet with a number. Whether that number is $10 trillion or $100 trillion makes no difference to the score sheet. The only limit is the artificial “debt limit,” on which Congress votes periodically. There is no functional limit on what any balance sheet can read. The government can write a check of any size, despite zero taxes.

Taxes may be levied for several reasons, but supplying the government with spending money is not one of them. The government creates money by spending. It does not use tax money. Therefore, all federal debt is sustainable.

Adverse effect: One possible adverse effect often mentioned is taxes. (“My children and grandchildren will have to pay for today’s deficits.”) But, we just saw that taxes do not pay for deficit spending. We are the children and grandchildren of the Roosevelt and Reagan eras. We never have paid for those monster deficits. The mantra about children and grandchildren is a myth.

A second possible adverse effect is inflation. Contrary to popular faith, inflation is not “too much money chasing too few goods.” That is an obsolete slogan. Today, we live in a world economy. Given sufficient money, there never can be too few goods in the world to sell. Instead, inflation is loss of perceived money value compared to the perceived value of goods and services.

The phrase, “too much money chasing too few goods,” addresses only supply. Inflation however refers to supply and demand, for money and for goods and services. The demand for money can change without a change is supply, and is related to interest rates. The demand for goods and services can change similarly, but generally increases when money supply increases.

Since we went off the gold standard, in 1971, there has been no relationship between deficits and inflation. In fact, the largest deficits have corresponded with the lowest inflation. See the graph, below:

Instead, inflation has corresponded with oil prices. See how inflation and oil prices move in concert, but oil moves much more, indicating oil prices are “pulling” inflation. (See the chart, below) Oil is the one “good” that can be in short supply and affect the prices of all other goods and services.

Oil prices and inflation

Despite the fact that large deficits have not caused inflation, I suspect there may be a point at which truly gigantic money supply growth could lead to inflation. We’re just nowhere near that point, as witness the current deflationary concerns.

At any rate, if inflation ever did crop up, the government would increase interest rates to increase the demand for money.

Beneficial: New York, a large economy, needs more money than does Peoria, a smaller economy. In fact, by definition, large economies need more money than do smaller economies. So for an economy to go from smaller to larger, its money supply must grow.

If you feel economic growth is beneficial, you also must feel money growth is beneficial. Federal deficit spending is the way the government adds money to the economy to make it grow. Federal deficits are beneficial.

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Does this seem like it would be clear to the average person? What are your suggestions?

Rodger Malcolm Mitchell
http://www.rodgermitchell.com