Inflation: Our Cure for Debt
By Randall Holcombe • Friday April 9, 2010 12:07 PM PDT • 8 Comments
As the Greek government slides closer to default because of its crushing deficits and level of debt, more than one American has asked, in light of our huge projected budget deficits, whether the U.S. government could be in that position someday. Paul Krugman says that the responsible policy for the U.S. to follow is to inflate away our debt, an option not open to the Greeks who are part of the euro zone. So no, we can avoid a repeat of the Greek tragedy.
We’ve done it before, Krugman says. After World War II our debt as a share of GDP was larger than Greece’s is now, but a decade later we lowered the debt to GDP ratio thanks to economic growth and, especially, inflation.
The parallel doesn’t exactly hold because the era Krugman refers to in American history was an era of balanced government budgets, whereas Greece is hoping, through austerity measures, to get its deficit below 9% of GDP.
But, there is some truth to Krugman’s story. The Greeks are stuck with European monetary policy as long as they stay in the euro zone, which prevents them from using inflation to reduce their debt burden. Meanwhile, there is nothing to stop us from inflating our debt away.
With the national debt in excess of $12 trillion and deficits projected to fall to under $1 trillion (Wow, it’s hard to write such big numbers!), 10 percent inflation would keep the real value of the debt about the same, or maybe even reduce it a bit.
We’ve done it before, and nobody seemed to complain much. During the 1970s the value of the dollar fell by about half because of inflation, and while people did complain about the inflation, nobody said much about the fact that in effect, by 1980 we defaulted on half the debt we had in 1970.
So, don’t worry about the national debt, or the budget deficit. But do watch out for inflation.
But there is another variable here to consider that has not been given enough attention. The federal government needs to worry not only about debt it has already incurred, but its unfunded obligations. And if you think about the nature of the latter, inflation will compound these disasters in waiting greatly. Social security benefits are indexed to inflation. Medicare provides for medical services, not fixed dollar payments, and so if price inflation takes hold, these costs for medical services will soar. And of course medical price inflation has long been running at about twice the rate of the overall CPI. So I am really not too sure that there is a way to inflate out of this mess.
D. Saul Weiner | Apr 9, 2010 | Reply
One big complaint in the 1970s was that taxes were not indexed for inflation (“bracket creep”). Let’s hope they don’t inflate our taxes as well as deflate the debt (in real dollars).
Jonathan Bean | Apr 9, 2010 | Reply
I made the same point in a Mises Daily article that D. Saul Weiner makes here. While Paul Krugman is correct to suggest that we did inflate our way out of debt after the Second World War, he conveniently forgets that much of our debt is the product of social insurance programs. The Obama administration is only planning to increase the amount of long-term government welfare programs, and this is likely going to make up a large portion of future debt.
You cannot inflate out of long-term liabilities because these will also rise in price. There has to be a decrease in long-term government spending in order for inflation to have the desired effects.
Rather, I believe that the future holds inflation, high government spending and very low economic growth.
Jonathan Finegold Catalán | Apr 10, 2010 | Reply
The unemployment rate will also drop and that will make the politicians even more happy...until they realize that they’ve grabbed “A Tiger by the Tail.”
Ian Ellis | Apr 10, 2010 | Reply
Am I mistaken or is the author in support of inflating our way out of debt? How is inflation not taxation? Or counterfeiting for that matter? The taxpayer is still left with the bill by paying higher prices during consumption. The conclusion “So, don’t worry about the national debt, or the budget deficit. But do watch out for inflation.” is mind-numbingly void of any intelligence. The very reason to worry about national debt and deficits is inflation.
Ryan in Scotland | Apr 12, 2010 | Reply
Inflation is theft and it hurts the poor and middle class the most. People must become aware of these facts and demand that the US end the warfare/welfare state that has brought us these insane levels of debt.
T Zimmer | Apr 12, 2010 | Reply