Home > Macro/Monetary Theory, Uncategorized > Inflation and the Deficit

Inflation and the Deficit

You may have noticed that I haven’t posted anything in quite a while.  Well I have made several attempts but I keep giving up in the middle because the thing I want to explain is very complicated–too complicated I think to explain well in one post.  Admittedly, it is basically the thing I have been trying to explain for a while now but my understanding of it is evolving, as are circumstances on the ground so I want to kind of start over and take another crack at it.  It will probably be an ongoing process as I look for a way to make it very clear to a casual reader.  So what I’m going to do is just blurt out the main point here to try to generate some interest and get you thinking about it and then I will try to fill in the blanks piece by piece later on.

The main point is this: The people on the right who want to balance the budget and pay down the debt need to realize that this will collapse the economy.  I am not saying that this means we shouldn’t do it.  I am just saying this because I don’t think conservatives understand the consequences and what else would have to be done to rectify the situation.  These things will be very drastic and somewhat disruptive to existing institutions.  Pursuing only one part of the solution (reducing the deficit/debt) is likely not only to make our economic problems worse but to cause a political and intellectual backlash that could set real progress back generations. 

Here I will lay out the basics of the argument in broad strokes.  The expansion of money through credit causes inflation in the short run but causes a tendency toward deflation in the long run.  The failure to foresee this deflation, which is propagated by the monetary authority, causes the tendency toward deflation to also be a tendency toward contraction.  This tendency is a direct result of expansive monetary policy, it is not random.  Furthermore, it cannot be managed indefinitely by the monetary authority alone because the contractionary pressure must be combatted by increased expansionary pressure (more lending) but this always causes even more contractionary pressure in the future which necessitates even more lending in the future.  We went off the gold standard (internationally) in 1971.   Here is a graph of the consumer price index

But eventually you cannot induce more private borrowing with lower interest rates because you can’t lower them below zero.  At this point the borrowing must come from somewhere and it comes from government.  If the government didn’t borrow tons of money, the whole money supply would be sucked back into the Federal Reserve, prices would plummet, and bankruptcy and default would run rampant.  The other side tends to argue that government spending is needed to boost aggregate demand to stimulate the economy.  Well of course the idea of aggregate demand is nonsense but this argument dances around a real issue.  It’s not that the government must spend, it’s that it must borrow.  It must borrow to keep the money supply from contracting which would cause prices to fall which would causes debtors (which is practically everyone thanks to the expansionary monetary policy) to default which would cause the economy to come to a screeching halt.  Here is a graph of the national debt (adjusted for inflation). 

You should watch this episode of Glenn Beck, especially the part about 14:50 in.  The Fed is now buying 70% of government debt. 

So you see it’s not a matter of the government needing to spend a certain amount and not having enough revenue requiring it to borrow.  It’s actually that the government must borrow a certain amount to maintain the needed money supply and then having to find stuff to spend it on.  That’s why Keynesians always support the proverbial digging of ditches and filling them in again.  It’s not the ditch digging that is important it’s the creation of money through debt–government debt.

  1. little fish
    March 15, 2011 at 3:42 am

    So the government borrows money into existence? I thought the government loaned money into existence. And I get that it has to borrow so it can loan, but if it is just the government playing with itself, how does that help anything?

  2. Free Radical
    March 15, 2011 at 7:25 pm

    The Federal Reserve loans it to the Federal government. The Federal Reserve is not really the government it’s a private cartel of bankers. They create the money but they can only create it if someone is willing to borrow. If not enough private people are willing to borrow to create the money the federal government must do it. It helps because it increases the money supply which keeps prices rising. But it also increases the debt because it’s not just the government playing with itself it’s the government playing with the Federal Reserve.

  3. little fish
    March 16, 2011 at 1:38 am

    Okay, that is helpful. I will keep reading your posts on this and see if it becomes more clear. Specifically, I’m having trouble with the last part of this sentence – “the expansion of money through credit causes inflation in the short run but causes a tendency toward deflation in the long run.” I hope you will explain how expansion through credit causes deflation tendencies. Thanks.

  1. No trackbacks yet.

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Google+ photo

You are commenting using your Google+ account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )


Connecting to %s

%d bloggers like this: