Why the U.S. Can’t Inflate Its Way Out of Debt

By | April 20, 2010

http://xenophilia.com/wp-content/uploads/2010/04/Inflation.jpgThis country is in piles of debt. Projections for how much more we could load on in the coming decades are downright nightmarish. You think it’s bad now? Just wait.

It’s obvious that big changes are in store, but progress (or even the hope of it) is painfully absent. Eventually, Stein’s law — if something can’t go on forever, it won’t — will prevail, and we’ll be forced to fix the problem.

How we’ll do so is the trillion-dollar question. There are only three ways to end runaway deficits: cut spending, raise taxes, or allow deliberate inflation.

The easy way out

The third option is often cited as the “tried and true” method, and not in a good way. Indebted countries habitually ask their reserve banks to run the printing presses at full bore. Governments can then pay their bills with the newly printed money, at the cost of inflation. This eliminates debt without forcing politicians to make unpopular decisions on spending and taxation, which is why it’s so prevalent.

But the idea also has a growing chorus of nonpolitical supporters. As an MSN Money article published on Wednesday titled, “Why Inflation Would Be Good For Us,” declares:

… a quick bout of higher-than-normal inflation would lower the nation’s debt in real dollars, bailing the government out of the debt threat. That means we could avoid Draconian tax increases or big spending cuts, both of which would be politically unpopular and could scuttle the economic recovery.

Sounds neat! Too bad it’s fantasy thinking.

The timing of this article was unfortunate. Just 18 hours after it was published, Fed chairman Ben Bernanke sat before the Joint Economic Committee, which asked him point blank about inflating away debt. His answer gets to the heart of the matter: “Given the structure of our debt, [inflation] wouldn’t even help reduce the debt … given that so many of our obligations are indexed.”

Bingo. Inflating away debt only works when the obligations are in fixed dollar amounts, like a mortgage. But essentially, all of our long-term fiscal problems are entitlement commitments that grow (are “indexed”) with inflation. When inflation rises, spending on Social Security and Medicare rise at the same rate. So the debt-inflation relationship is the opposite of the get-out-of-jail-free card some envision. Debt still goes up in real dollar terms, creating even more of a death spiral. …

via Why the U.S. Can’t Inflate Its Way Out of Debt.

Leave a Reply