Deficit Reduction and the Coming Inflation?

Would a higher rate of inflation be a worthwhile tool for lowering the federal deficit?

Some in Washington, DC, think so.

In a blog post written last month, Doug Elmendorf, director of the Congressional Budget Office (CBO), makes the case that greater inflation would raise revenue more than it would raise spending. Here’s an excerpt:

Inflation as measured by the consumer price index averaged 5.1 percent annually during the 1980s and is projected by CBO to average 2.2 percent over the coming decade. If CBO assumed that inflation over the next decade matched the average seen during the 1980s, to parallel the assumption about interest rates, projected tax revenues would be much higher than in CBO’s baseline projections, and federal spending would be moderately higher. On balance, those two effects would reduce deficits.

Next question: Would the Federal Reserve get on board with the plan?

Again, CBO thinks so. In its February publication Budget and Economic Outlook, Fiscal Years 2013–2033, the agency is forecasting that Ben Bernanke and company will increase the Fed’s holdings of government bonds and mortgage-backed securities in 2014 and 2015.

The more securities bought by the Fed, the logic goes, the lower the government’s cost of borrowing. (The illogic of ignoring what happens to interest rates once the public realizes that prices are rising faster and faster can be addressed at some later date, after policymakers finish dealing with the current mess.)

Many years ago, when price inflation was the crisis at hand, I heard some oblivious pundit (on The MacNeil-Lehrer New Hour, as we called it then) hail the Federal Reserve as “the country’s best inflation fighter.” Now it seems that some in Washington are trying to soften up the public for a counterpunch: the Federal Reserve as “the country’s best deficit fighter.”

Tuck your chin, and keep your hands on your wallet.

HT: Rick Ferri