Excessive debt doesn't cause inflation
By Scott Sumner
I cannot resist responding to a recent article by Stephanie Kelton, explaining the MMT view of public debt:
Since the government’s budget deficit is, by definition, the difference between what it spends and what it collects in the form of taxes and other payments to itself, it may seem reasonable to call it “overspending” when the government spends more than it takes in. But it’s not.
As every economist knows, inflation — not a budget deficit — is the tell-tale sign of an economy that is under pressure from excessive spending. If prices aren’t accelerating, you don’t have an inflation problem. And if you don’t have an inflation problem, you don’t have a spending problem.
It’s rare to see such a classic example of a non sequitur. Yes, inflation is a sign of overspending, in the sense of excessive aggregate demand. But in context, the second paragraph makes no sense at all. The previous paragraph was not about aggregate spending, it was about federal spending and the budget deficit. Indeed the entire article up until that point is discussing budget deficits, and nothing else. For instance, here’s the first paragraph:
When I was the chief economist to the Democrats on the Senate Budget Committee in 2015-2016, I attended a number of hearings, all called by its chairman, Republican Senator Mike Enzi of Wyoming. He would invariably open with prepared remarks that included his observation that deficits are evidence of “chronic overspending.”
So then what are we to make of the paragraph that begins “As every economist knows”? There are two possibilities here:
1. Kelton is referring to excessive federal spending. But in that case, the claim is completely false. Economists do not generally believe that inflation is a tell tale sign of excessive federal spending, mostly because it obviously is not. Deficits tended to be low during the Great Inflation, and then rose sharply in the 1980s, as inflation fell sharply. Deficits again soared over the last few years, again without high inflation. So it’s certainly not true that “every” economist regards inflation as a sign of excessive federal spending, rather economists view it as a sign of excessive aggregate spending.
2. OK, so perhaps that’s what Kelton meant. But then the entire article makes no sense. She had been trying to push back against the view that excessive federal spending and large budget deficits are a problem when inflation is low. If the paragraph about what “every economist knows” is referring to aggregate spending, then it has no bearing on her claims. In that case, the entire article literally makes no sense at all. Her “proof” has no bearing on the claim she is disputing.
This is also puzzling:
Depressed conditions meant that the government could have spent a trillion dollars without raising a single tax. It would not have been inflationary. But as things tighten up, and the slack dissipates, the economy moves to a fuller utilization of its resources.
We almost never make it all the way to maximum velocity — we did during the mobilization for World War II — and we’re almost surely not there now. That day could come. And when it does, you don’t get to spend so freely.
Put aside the odd comment about “velocity”, which was actually relatively low during WWII (albeit slightly higher than in 1940). She’s right that excessive (aggregate) spending did cause substantial inflation during the war. But the suggestion that inflation is only a problem when we reach full utilization of resources makes no sense. Yes, the unemployment rate fell to barely over 1% during WWII, and we were certainly operating at capacity. But we also had double-digit inflation during 1980 and 1981, a time of 7% to 8% unemployment. In other countries you can find even more extreme examples of stagflation. Excessive spending can occur when the economy is far from capacity.
Just to be clear, I don’t expect the current federal deficits to lead to high inflation, due to monetary offset. So it is reasonable for MMTers to predict low inflation for the foreseeable future. The financial markets also predict low inflation, as do most mainstream economists. But that’s not the point. While big budget deficits lead to hyperinflation in places like Zimbabwe and Venezuela, in the US the deficits are likely to place a burden on future taxpayers, slowing growth. Sharp future tax increases are the actual risk, not high inflation.
PS. I’m expecting commenters to tell me that MMTers use terms like ‘velocity’ and ‘spending’ in a way that’s radically different from how mainstream economists use these term. They seem to have their own private language.