Why Inflation Is Not Caused by Deficits and Government Spending, According to Republican and Conservative Economic Theorists

Supporters of fiscal austerity and economic conservatives often blame deficits and increased government spending for rising inflation. However, this view is not supported by economic theory and historical evidence. The real cause of inflation lies elsewhere: a general increase in the supply of currency, leading to an oversupply that drives up prices.

Understanding Currency and Inflation

Inflation is a complex economic phenomenon. Historically, it has been linked to an increase in the money supply, primarily through central bank policies. When a government spends more than it taxes, it often borrows to make up the difference, effectively increasing the amount of currency in circulation.

Money Supply and Productivity

The concept of savings is deeply rooted in productivity and the allocation of resources. When individuals save money, they are essentially setting aside resources for future use, ensuring that these funds are available for future investment. This saved currency, in turn, supports economic growth by providing capital for profitable ventures.

Government borrowing, on the other hand, introduces new currency into the economy that does not have the same backing in productivity. This new, unearned currency can fuel inflation as it bids up the prices of available resources. This phenomenon is not unique to government spending; it can occur through other means, such as counterfeit money.

Interest Rates and Inflation

Republican and conservative thinkers often argue that rising interest rates are a consequence of government borrowing, leading to inflation. However, this reasoning is flawed. Interest rates are a reflection of inflation expectations, not the cause of inflation.

Historically, economic theories have evolved, and many of Milton Friedman's ideas have been challenged. Modern economists, including those who contributed to the field of behavioral economics, have proposed alternative theories. Since the financial crisis of 2007-2009, even high-profile economists like Alan Greenspan have acknowledged that previously held beliefs may not be accurate.

Fixed and Flexible Money Supply

During the era when currency was pegged to precious metals, the fixed supply of money helped prevent inflation. However, this system led to various economic crises, including recessions and depressions, as it limited the capacity for economic recovery. Today, most currencies are not tied to metal, allowing for greater flexibility in the money supply.

Central banks, like the Federal Reserve, do not directly control the money supply. Instead, they manage monetary policy and influence interest rates through various tools. Quantitative easing (QE), for example, is a tool used to inject liquidity into the economy, but its effectiveness in controlling inflation is limited.

Conclusion

In conclusion, deficits and government spending do not inherently cause inflation. Inflation is caused by an increase in the supply of currency, which can lead to a bidding war for scarce resources. This is a complex issue that requires a nuanced understanding of economic theory. It's crucial to challenge established economic paradigms and consider the evolving nature of currency and economic policy.