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? asked in Social ScienceEconomics · 1 decade ago

Reducing the Deficit. Inflation?

I was watching some of the ben bernanke congress talks a few days ago and something came up that intrigued me. A congressman asked if it would be possible to use inflation to lower the national deficit. Bernanke said that too many parts of gov. were based off of inflation, so it wouldn't work. Could someone explain how one might go about using inflation in this fashion, and could someone explain bernankie's answer?

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  • 1 decade ago
    Favorite Answer

    You are confusing "deficit" with "debt". Those two words mean two different things.

    It boils down to this: if you owe a debt, inflation does not make that debt increase, but it does make your income increase. If the debt remains at X dollars, the real value of that debt shrinks due to inflation; and the manageability of that debt improves thanks to your inflated income.

    As Meg alludes to, the size of the national debt in dollars is not too meaningful, what's important is the size of the debt relative to the nation's GDP. If GDP was twice as high, the current 12 trillion debt would be a lot less threatening. Economists look at the debt:GDP ratio as an indicator of whether the debt is manageable or getting too high.

    Now, the the NOMINAL size of the GDP usually increases each year based on two components -- inflation, plus "real" growth. "Real" refers to a number adjusted for inflation. Inflation does not help REAL economic growth, but it does increase the nominal GDP growth: if price tags go up, then the amount of commerce in dollars increases based on inflation alone, even if there was no increase in the REAL value of market activity.

    The current yearly US GDP is about $14 trillion ... imagine if inflation alone made that increase to $20 trillion, then $25 trillion, then $30 trillion, etc. If the debt was stable or grew more slowly, it would become more manageable.

    So that's what the Congressman was asking about ... if we spurred high inflation, could that increase nominal GDP and make the accumulated debt more manageable? He asked, because a lot of people talk about this, and some think the U.S. is secretly planning to do this.

    Bernanke claimed that that wouldn't work, because enough government spending is tied to inflation, that inflation would cause a big increase in government spending, and thus big deficits, hence making debt grow rapidly, and defeating the strategy.

    Probably, Bernanke is lying and he exaggerates the effect of inflation-based increases in government spending. But a central banker like him cannot be seen as supporting rapid inflation, so this is the answer he has to give.

  • meg
    Lv 7
    1 decade ago

    The Fed increases the money supply by buying government bonds with created money and we no longer have to pay interest on these bond so it is like we never borrowed the money. However in doing this, they would create inflation. If there is inflation GDP rises and so would government revenues and the debt to GDP ratio would fall so in principle the interest on the debt would consume a smaller fraction of the budget. But Social Security is indexed for inflation and one would expect Health care and the other things the government pays for would also increase if there were inflation so government spending would increase with the revenues. But the most important thing is that the debt nearly equally to the GDP. Interest rates tends to equal the inflation rate + real rate. For example if the inflation rate were 10% this year, next year government spending would increase by about 10% however the interest on the debt which must be refinanced next year would increase by nearly 10% of the amount, not by 10% of the interest we paid this year.

  • 5 years ago

    Bush's 2007 deficit was under 200 billion (with a "B"). The mortgage meltdown made him spend a trillion on TARP, a one-shot expendanture. Obama hasn't spent LESS than one trillion each year. This year is projected to be about the same, with little let up in sight. Fiscal years imply a budget. The Obama Administration hasn't even OPERATED under a budget since taking office. The Bush budget (FY2009) being the last. It sounds like you are listening to only the commentary on yearly deficits you want to hear. The defitics may not be growing, but they are still trillion dollar ones for the indifinate future. Until the deficits are eliminated, the DEBT continues to grow. In fact, the size of the deficits is a measure on how fast the debt is growing.

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