As I’ve noted on previous occasions, I’m not a fan of Ben Bernanke and his actions at the Federal Reserve, though it is possible that QE2 may be the right policy (albeit for different reasons than publicly stated by the Fed Chairman).
I’ve had several people say to me, however, that it doesn’t make sense for the government to engage in an inflationary monetary policy because that will worsen the fiscal situation. Why inflate, after all, if it results in higher cost-of-living adjustments for Social Security recipients and higher pay for government bureaucrats?
My first response is to say that long-run fiscal policy almost surely is not a big (or even little) factor in monetary policy decisions. Central Banks tend to behave poorly for short-run reasons such as financing deficits (a problem in the developing world) or manipulating interest rates in hopes of goosing growth (a problem is all nations).
It goes without saying, of course, that a series of bad short-run policy decisions translates into bad long-run policy, which is why the dollar has lost 95 percent of its value since the Federal Reserve was created.
My second response is to tell folks that we should hope that long-run fiscal policy is not a factor in monetary policy. Because they are right that inflation leads to higher expenditures, but the government reaps a big windfall from higher tax revenue.
But don’t believe me. You can find this information in Table 3.1 on page 23 of the Economic and Budget Analysis section of Obama’s budget.
Addendum: Welcome, Instapundit readers. Since this is a depressing topic, you can see some Federal Reserve humor here, here, and here.
And if you want to really understand what wrong with the Fed, this is the video to watch.
[…] The incentive doesn’t even require a belief in a nutty idea like Modern Monetary Theory. Government can profit from inflation in a more subtle way, as I wrote way back in 2011. […]
[…] First, inflation is obviously bad for citizens. But as I wrote more than 10 years ago, it’s profitable for governments. […]
[…] First, inflation is obviously bad for citizens. But as I wrote more than 10 years ago, it’s profitable for governments. […]
[…] First, inflation is obviously bad for citizens. But as I wrote more than 10 years ago, it’s profitable for governments. […]
[…] Indeed, it’s fundamentally immoral to let the government profit from inflation. […]
Jimbo,
1K in 1970 dollars would have $5611.55 buying power in 2010 dollars …. ahhh you do the math.
the Fed is a perfect example of milking inflation for everything it is worth. Under the guise of maintaining an “employment hedge” or should I say “unemployment hedge” the Fed plays the “fool the bigger idiot game” by understating inflation when it excludes increases in energy and food costs in its inflation calculations. Presently the Chinese hold the title “biggest idiot” and continue to do so as they turn out i droves at our Treasury auctions. This game allows the US to repay its debt with cheaper dollars at a relatively minimal premium when considering what the “real” rate of inflation is. You would get a better idea of that rate by reviewing the rate lenders charge on their short term loans vis-a-vis credit cards. The government is not the sole beneficiary of this practice, however, the private sector, i.e. corporations, has reaped huge gains by cashing in heavily leveraged assets with cheaper dollars. The party may be coming to an end, however, the Chinese are in near panic mode over their homegrown out of control inflation and the EU is poised to begin a tightening policy to deal with their own inflation issues.
Inflation will not improve the fiscal situation. And it won’t happen.
Click to access cover.pdf
“the dollar has lost 95 percent of its value since the Federal Reserve was created”
Yeah, I hear this all the time from goldbugs, but who really cares? All the dollars are still worth more now than all the dollars back then. Real living standards have risen. If you’d taken those dollars and invested them, you’d still be far ahead in real terms. So why the obsession with freezing the value of a dollar at some arbitrary point in time?
In response to Andy. I’m POA for my parents who are both dependent on SS for their income. (my dad managed to throw away millions in retirement savings as he aged and lost his ability to deal with his own money–we, his kids were unaware of the extent of his loss of perspective). The government does NOT give COLA’s according to any real measure of inflation. Costs can be skyrocketing for essential goods and they simply don’t count these in the basket of goods that they use to determine the rate. Since they make up the rules they can determine the outcome they want.As a result they can make up their losses incrementally by not paying out small amounts to millions of people. Ever see Superman III? Office Space? Then you know what I’m talking about.
Most entitlement programs (SS, medicare) are inflation-protected, so inflation doesn’t help with them.
Note that we give inflation adjustments to SS recipients even when there’s no inflation….
> Inflation helps all debtors.
No. Inflation only helps folks who have fixed-interest rate debts incurred before the expectation of inflation.
Lenders aren’t stupid. When they expect inflation in the future, they insist on higher rates to account for said inflation. If the expected inflation happens, they’re even and if it doesn’t happen, they’re ahead. Lenders lose only if they underestimate inflation.
One way to exploit “underestimate inflation” is to induce hyper-inflation. Is that the plan?
QE2 is a not a domestic economic policy, it as a geopolitical strategy. You saw the headlines yesterday about the financial crisis as an act of economic war? QE2 is causing global inflation for food and as a result is causing the revolutions and protests around the world. This is a counter attack in the economic war.
Who benefits? My daughter. Whenever the topic of her student loans comes up, I reassure her that she is aligned with the federal government and she’ll get inflated out of her student loan debt with them.
I also tell her that the only possible hitch to this solution is if the Chinese declare war on us for trying to pay them back 40 cents on the dollar.
‘which is why the dollar has last 95 percent of it’s value’—-
That should read, –which is why the dollar has LOST 95% of it’s value…
Inflation benefits debtors by allowing them to repay debts in CHEAPER dollars; by “cheaper”, I mean in real terms. The nominal amounts will still be the same. If someone (say, the US govt) borrowed $100 in 1975 and paid it back in 2005 (basically a 30 yr bond) they would give the lender $100 in nominal terms but it would only be about $20 in 1975 terms. So they borrowed $100, inflated the currency and paid back $20. Cool system, eh?
So all of today’s entitlement recipients (social security, medicare, etc) may well get what they are entitled to in nominal terms. But the gummint is printing money these days, the money will likely be worth less than the value of the fuel one uses to go down and cash the check (if anyone is willing to cash it.) Party ON!
It also reduces the debt, no?
I meant to say, with dollars that are worth less! Sorry!
Erich – inflation won’t help with new projects, but it does help with projects already completed and paid for with dollars that were worth more.
For example, say the government built a road for $1 million dollars and borrowed money to pay for it.
The fed encourages inflation.
The government then pays back that $1 million debt with dollars that are now only worth maybe $700 thousand – and yet the road itself has not lost its value, it has gained in value.
Inflation helps all debtors. It hurts savers.
You could argue that does dilute the dollar and its purchasing power, but power is what this bunch in Washington is after any way they can get it. Lousy economic policy for us, evil political policy for them.
“Because they are right that inflation leads to higher expenditures, but the government reaps a big windfall from higher tax revenue.”
Who is Dan Mitchell kidding? More inflation might bring in more tax revenues nominally, but that won’t mean the government is richer, in real terms. Say the government gets more money, nominally, to fund a pork project for a museum. The number of tax dollars will be higher, but it will cost more to hire workers, buy equipment, by materials, etc. We all know inflation of the money supply raises prices, right? Inflation creates the illusion of wealth and prosperity. I thought you were smarter than that, Dan!