Michael Bordo and Mickey D. Levy write,
the initial response combined aspects of the policy response in several overlapping crisis scenarios in the past: World Wars I and II, the Great Depression, and the Global Financial Crisis (Bordo, Levin and Levy 2020). These earlier episodes of induced fiscal and monetary expansion in the 1930s and the World Wars led to rising price levels and inflation. In this paper we survey the historical record for over two centuries on the connection between expansionary fiscal policy and inflation and find that fiscal deficits that are financed by monetary expansion tend to be inflationary.
Do not assume that the last ten years settle the issue of whether deficits are inflationary.
Debt:GDP is at roughly 1945 levels. I don’t know the timeline (could be decades), but it will be inflated away at some point for sure.
Arnold, at the beginning of their review’s last section, Bordo and Levy state: “We posed the question, under what circumstances do increased fiscal deficits lead to inflation Our historical survey of key advanced countries leads to the conclusion that the state of nature–war or peace–is a key determinant of the connection between fiscal deficits and inflation.”
They have done a very poor review of the historical record. Indeed, the financing of wars have often been a cause of hyperinflation and high inflation (I wonder how they can ignore Campbell and Tullock review of hyperinflation in China in the 20 years up to October 1949), but you can easily find stories of hyperinflation and high inflation due to accelerated increase in fiscal deficits in several Latin American and African countries. How can they ignore the experience of Argentina in the 1980s?
More importantly, they ignore how important the changing access to credit has been to the financing of fiscal deficits, in particular, since 1970. The large expansion of credit markets since 1970 has allowed many governments to increase their fiscal deficits. Just look at what has been happening in China for the past 40 years: how do they think the government has been able to finance the large increase in the spending of their state enterprises? The answer is quite simple: the state banks have been financing the state enterprises and the state banks have been intermediating the huge accumulation of family savings. Since 1995, some foreigners have been questioning how sustainable China’s financing of the state enterprises could be and predicting the end of China’s Ponzi game.
Frankly, I think the paper is a terrible starting point to discuss how the Biden administration will continue financing the fiscal deficit if it’s not reduced, and especially if the deficit is increased. If you want to challenge Paul Krugman and other phony economists on their grotesque prediction that the deficit, regardless of its size, can be financed by credit forever, you have to provide a good analysis of how credit markets work –even if the borrower is the U.S. Treasury of the Fed (for all practical purposes they are just one demon with two heads)– or you can ask Martín Guzmán, Argentina’s Ministro de Hacienda (he is a Brown U. Ph.D. in Econ and a protege of Joe Stiglitz).
Well, look at that! Biden has already cured the Republican’s four year case of deficit attention disorder.
Your turn to grasp the nettle.
Sorry, Tom. You are asking to grasp the nettle to those who have been suckling on the Treasury’s teat forever!
Is he a farmer in Iowa?
No. In DC.
Sorry, this was a reply to Moo cow. Biden is a liar in DC.
The expression “suckle on the Treasury’s teat forever” was used by President Uhuru Kenyatta a few months ago. Little has changed since the times in which I used to visit Nairobi in the early 1990s to prevent it.
Fiscal deficits *that are financed by monetary expansion* are inflationary? But in fact (excessive) monetary expansion in itself is inflationary, whether or not it is accompanied by fiscal deficits; while fiscal deficits not accompanied by (excessive) monetary expansion are *not* inflationary, because of “crowding out.”
Right now we have quite moderate, non-excessive monetary expansion; so: little inflation. The deficits may be undesirable, but not because of inflation.
Doesn’t the experience of Japan over the past two decades settle it?
You’d think that inflation would be the last thing officials want if high deficits are continuing to be run. Higher inflation will lead to sharply higher market rates, both to cover the inflation and additional risk premium on top of that as many will see a sizable risk of inflation rising even higher.
I think the smarter play would be to target zero inflation and push nominal rates to zero or even negative, such that the debt is neutral or even net-positive with respect to the deficit. Seems to be Japan’s strategy and (so far) it can accommodate massive levels of debt.
I don’t know the details of how the Japanese government has been financing its deficits. I bet that somehow they have been relying on the Bank of Japan’s borrowing from domestic financial intermediaries. Do you know anyone that has studied in detail the consolidated balance sheet of all financial intermediaires, including the Bank of Japan, over the past 40 years?
Silver and gold, silver and gold
Ev’ryone wishes for silver and gold
How do you measure its worth?
Just by the pleasure it gives here on earth
– Burl Ives
As Herbert Stein famously said, “If something cannot go on forever, it will stop.” We cannot finance government expenditures with high levels of debt forever. Nor can we have negative real interest rates for very long because, at negative real interest rates, even uneconomic projects can borrow (large amounts) profitably. Eventually, inflation and interest rates must rise; the two questions are when and whether voluntarily through economic policy (and thus implicitly gradually) or involuntary through a global lenders’ strike (and thus implicitly suddenly).
The authors “find that fiscal deficits that are financed by monetary expansion tend to be inflationary.”
“Tend” is a rather large word in this context, no?
Do money-financed fiscal programs “tend” to lead to inflation…but only if overdone?
I would say that 2020 is the perfect year for hyperinflation. There has been plenty of money printing at the Fed, plenty of huge deficits and we have curtailed output through government edict.
So far, sophisticated institutional investors on three continents say no inflation is in the picture, not now and not for 10 years.
Time will tell.
Highly intelligent macroeconomists have spent the last 40 years predicting higher rates of inflation and interest rates, in the US. Instead, the opposite happened.
Will the next 40 years obtain the same track record?
Arnold, I was going to write something about the need to address public expenditure and taxation before worrying about how deficits are financed, but then I read David Henderson’s last post published last Thursday:
https://www.econlib.org/joe-stiglitz-on-taxes/
and I prefer to comment on it (I cannot comment in Econlog because Scott Sumner didn’t like a comment I wrote about how wrong he was about his monetary theory and policy–besides, he knows nothing about China despite visiting his Chinese in-laws for the past 100 years).
David’s post starts with a quote from Stiglitz, Economics of the Public Sector, a textbook that I used years ago when I taught Public Economics/Pubic Finance/Public Choice. It’s a very good quote because in a few lines summarized key ideas which David then comments. My point has always been that we should emphasize those key ideas before discussing deficits and their financing. The tragedy of Argentina and other countries with large deficits and huge problems to finance them is the large income redistribution that their governments have been attempting for a long time (also, we should remember that the amounts in public finance statistics, like those used by the IMF, underestimate spending, tax and other revenues, and the deficits –in some countries, the underestimation is huge).
Most of the “macroeconomic” analysis of public finances is a grotesque joke. The T and the G that macroeconomists like to use have nothing to do with public finance statistics (the ones published and the ones that nobody has estimated). You should remember the discussion among phony macroeconomists about the fiscal multiplier of Obama’s 2009 “stimulus” plan (I bet that over 80% of the expenditure was for income redistribution in favor of high and middle-income democrats).
Yes, we should be worried about large deficits and their financing, but first, we should be worried about spending and taxation because their negative effects may be much larger than the effects of relying on the inflation tax or borrowing to finance the deficits.