The Paul Ryan budget plan released Tuesday starts by laying out a grim scenario for America’s fiscal future: “Unless we change course, we will have a debt crisis,” it says. “Pressed for cash, the government will take the easy way out: It will crank up the printing presses. The final stage of this inter-generational theft will be the debasement of our currency. Government will cheat us of our just rewards. Our finances will collapse.”
Wow, grim stuff. It’s a dark outline of America’s fiscal future in the absence of some major overhaul of government finances, but Ryan is not necessarily alone in forecasting it. You can hear elements of that forecast in everything from the doom-and-gloom investment newsletter crowd to the language centrist deficit hawks who consider it a given that a debt crisis has already begun.
As my colleague Ezra wrote Wednesday, there’s a solid argument that today’s budget deficits are too small, not too large, and that future deficits are less of a crisis than Washington discourse would suggest. It’s worth diving into a second part of the Ryan view of the world, however: The idea that the Washington’s eventual reckoning with its debt problem will be through printing money, unleashing vicious inflation.
There is certainly historical precedent for governments funding themselves through the printing press and nasty inflation resulting: Most disastrously during episodes like the hyperinflation of 1920s Germany or early 2000s Zimbabwe; more prosaically by the likes of Italy’s central bank in the 1970s and 80s.
So could the United States follow their example? Many of the opponents of the Federal Reserve’s “quantitative easing” programs, by which they have pumped $2 trillion into the economy in recent years by buying government bonds and other securities, as a first step toward doing so.
But there are a couple of big problems with that theory. First, the items in the federal budget that are the overwhelming drivers of long-term deficits wouldn’t really be helped if the government were to unleash massive inflation. The federal government has pledged to pay for medical care for the elderly (through Medicare) for the poor (Medicaid) and provide basic retirement income (Social Security).
But for each of those programs, inflation wouldn’t solve the government’s financial problems. It would make them worse (to put it in the technical language, they are real obligations, not nominal obligations). In other words, if the Fed becomes feckless and allows double-digit inflation to take root, the cost of medical care will rise by double-digits too (or even faster, if the pattern of recent decades holds up). Social Security payments are indexed to inflation; that policy could be changed, but any politician who tried to freeze Social Security (particularly at a time of high inflation) would surely find gray-haired armies of angry seniors in their office making their dissatisfaction known.
So inflation wouldn’t offer Congress much of a way out of its deficit problems; indeed, it could make them significantly worse.
But the second assumption that Ryan’s dark vision of where government debt could lead us also demands another assumption: That the Federal Reserve’s tradition of independence will crumble and that a future Fed will allow inflation to get out of control.
This is possible, of course. It happened as recently as the 1970s, when Fed chair Arthur Burns allowed inflation to get out of control in no small part due to political pressure from the Nixon administration. An acquiescent central bank is crucial to understanding the inflation episodes mentioned above, in Germany, Zimbabwe, and Italy.
But a lot has changed since Arthur Burns’s time, and the idea that a central bank has not just the power, but the responsibility to prevent inflation from getting out of control is deep-seated within the Fed and other central banks. We don’t know who President Obama will appoint to the Fed chairmanship when the job comes open in January 2014, let alone who the next president will appoint four years after that. But the Volcker-Greenspan-Bernanke Feds have spent a long years building credibility around their determination to keep annual inflation around 2 percent. It would mark a remarkable reversal if within the next few years future Fed leaders decided they were willing to cast that record out the window.
In other words, if the Fed chair of the future does his or her job right, the central bank will not allow inflation to soar to 5, 10, or 20 percent just because Congress is too unwilling to make hard choices; rather, they would hike interest rates, reining in inflation and making the cost of deficit spending that much higher.
It’s true that the Bernanke Fed has been constantly pushing toward easier money in recent years. Bernanke also has been Fed chairman during a near-depression. If anything, though, the fact that the Fed has taken those steps even while they have been politically unpopular should give us more confidence that they will reverse course if a day comes when inflation is getting out of control—whether the politicians in charge like it or not.