All Commentary
Friday, December 3, 2010

Hummel and Richman at

Jeffrey Rogers Hummel, a Freeman contributor and associate professor of economics at San Jose State University, and Freeman editor Sheldon Richman have published a commentary at disputing that the government would benefit greatly from inflation through monetization of its debt:

Historically governments inflated their currencies because they benefited in various ways. For example, they spent the new money, gaining the purchasing power lost by holders of the depreciating currency. This gain, called seigniorage, is an implicit tax on the people’s cash balances.

Another way government can gain is in its role as a debtor. If inflation is unanticipated, interest rates will not have risen enough to compensate lenders for the decline in purchasing power. Net debtors gain, and net creditors lose. Government, of course, is the economy’s biggest debtor. During the Great Inflation of the 1970s private investors holding long-term U.S. Treasury securities actually earned negative real returns despite receiving positive nominal interest. So from 1946 to 1982, while the government’s nominal debt to the general public rose from $242 billion to $925 billion, in 1946 dollars it had actually fallen to $201 billion.

If in the past inflations were able to ease the government’s financial problems, this is less true now since globalization gives investors more options.

Globalization, with the corresponding relaxation of exchange controls in all major countries, allows them easily to flee to foreign currencies, with the result that changes in central-bank policy are almost immediately priced by exchange rates and interest rates. Add to this the ability to purchase inflation-indexed government securities, and it becomes highly unlikely investors will be caught off guard by anything less than sudden, catastrophic hyperinflation (defined as more than 50% per month)–and maybe even not then.

Thus it would take a mighty and unexpected inflation indeed for the U.S. government to benefit in its current fiscal predicament–but at what cost?

The full commentary in Forbes here.

Hummel’s original Freeman article on government’s diminishing benefits from inflation is here.