Saturday, February 19, 2022

How Government Spending Fuels Inflation

Rod's Comment: For those who don't understand the economic principle that government spending fuels inflation, this is recommended reading.

By Tunku Varadarajan, Wall Street Journal, Feb. 18, 2022- Annual inflation in the U.S. rose to 7.5% in January, the highest it’s been since February 1982, when it was 7.6% and declining. This current crisis, economist John Cochrane says, came as “a complete surprise” to the Federal Reserve. “All of the governors who reported forecasts, all of the staff, missed it.” When he calls this an “institutional failure,” he sounds almost kind. ...

He traces the present inflation to the pandemic and the government’s response. Starting in March 2020, “the Treasury issued $3 trillion of new debt, which the Fed quickly bought in return for $3 trillion of new reserves.” The Treasury then sent checks to people and businesses, later borrowing another $2 trillion and sending more checks. Overall federal debt rose nearly 30%. “Is it at all a surprise,” Mr. Cochrane asks, “that a year later inflation breaks out?”

Rod: When people say, the government "prints money," that is usually a euphemism for what is described above. The government actually prints little money. In the process described above, money was created out of thin air. It did not exist before and now it does.

He likens this $5 trillion in checks to a “classic parable” of Milton Friedman (1912-2006), the great monetarist at the University of Chicago, ... “Let us suppose now that one day a helicopter flies over this community and drops an additional $1,000 in bills from the sky, which is, of course, hastily collected by members of the community,” Friedman wrote in “The Optimum Quantity of Money” (1969). If they spent the money, inflation would result.

The Covid checks, Mr. Cochrane says, were “an immense fiscal helicopter drop. People are spending the money, driving prices up.”

Rod: The article goes on to explain why The Fed got it wrong. This is worth reading and here is a link. Unfortunately, only subscribers to WSJ can read the whole thing and while tempted to reporduce more of this ariticle I try to honor "fair use" and not infringe on copywrites. What I think is the most important part of the essay is the part I have quoted above. 

I am pleased to see the author say that there was also a lot of  needless stimulus under Trump as well. While many Republicans will try to call this inflation "Biden's inflation" and while Biden pushed more stimulus spending long past when it was needed, Trump deserves his share of the blame. And, it is worth recalling that Trump wanted even more stimulas spending that what Congress would approe.

While the Federal Reserve inflating the money supply may be the primary cause of inflation it is not the only cause. Also, those who think the money supply should never grow, are as wrong as those who think government spending and borrowing doesn't matter. We need a certain growth in the money supply to facilitate economic growth.

One falacy I often hear made by libertarians or conservatives with limited economic knowledge is that it is only government, primarily the Federal Reserve, that can cause the money supply to increase.  That is simpy not so. A growing economy has a constantly expanding money supply. Borrowing money creats money. It does not have to be inflationary, however. If growth in the economy matches the growth in the money supply, it is not inflationary.  Most money is created by fractional-reserve banking. This preexisted modern economies and central banks. If you in doubt about how most money is created, there is good explanation at  this link.




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