Chicago Fed Economists: Massive Deficits Don't Cause Rampant Inflation
Chicago Fed research economists Marco Bassetto and R. Andrew Butters have a lot of nerve, so much that they actually published What Is the Relationship between Large Deficits and Inflation in Industrialized Countries? and claimed within the paper that high inflation is not necessarily a consequence of massive deficits. I wonder if they are at all embarrassed by having their names attached to such a piece of obvious propaganda.
Examining industrialized countries, the authors find that large deficits are not associated with higher inflation contemporaneously, nor are they associated with the emergence of higher inflation in subsequent years. This finding suggests that countries that can afford large deficits have built solid reputations and institutions supporting a sound monetary policy and the reversion to a stable fiscal regime.
But they redeem themselves with this useful gem, which shows us that they understand the temptation for a government to use its central bank as an ATM (are you listening, Obama?):
High unexpected inflation: When unexpected inflation comes, it reduces the real value of previously issued debt. Unexpected inflation acts thus as a hidden default on debtors’ obligations. A government dealing with larger deficits faces a greater incentive to lean on the central bank and encourage higher inflation to alleviate its fiscal imbalance. This is a well-known source of the time inconsistency of monetary policy. Once the private sector’s expectations are locked into the nominal interest rate, any movement in inflation becomes “unexpected,” and the temptation to “inflate debt away” emerges. In our simple version of the budget constraint, inflation expectations are locked in for a single year, since all debt matures at the end of the year. However, in reality government debt has a longer average maturity; for example, the current average maturity of U.S. debt is 54 months. This gives extra time for inflation to act, and correspondingly increases the temptation for a government to inflate its debt away.8
I'm not sure what world these guys live in or how they were able to interpret chaotic and varying data to prove their point but if it's peyote count me out.
By the way, that footnote 8 (got to love the footnotes):
Missale and Blanchard (1994) analyze the relationship between the size of debt and its maturity structure in the case of Belgium, Ireland, and Italy, and show that the maturity structure varies inversely with the size of the debt/GDP ratio. They interpret this as evidence that a shorter maturity is needed to contain the temptation to inflate debt away when debt is larger.
And what was that about 54 month maturities on US debt?
Print faster, Zimbabwe Ben!!