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January 21, 2010

Deficits and Inflation

The Federal Government has been running enormous budget deficits during the recession. Some worry that these deficits will lead to much higher price inflation. Is this worry well-founded?

Dr. Mike Walden, North Carolina Cooperative Extension economist in the College of Agriculture and Life Sciences at N.C. State University, responds:

"Well, actually ... if you took a poll of people, most people would say, well, sure that the higher the budget deficit, the more likelihood that we will have higher inflation. But actually within economics, economists would say no, there is no necessary link between budget deficits and inflation.

"Inflation fundamentally results when the government prints too much money when the money supply is growing faster than the production of our farms and factories and offices. And that results in higher prices.

"A budget deficit means the government is going into the money markets and borrowing money. Now if the amount of money is the same, if the Federal Reserve, for example, hasn't increased the amount of money -- the amount of money is the same -- what a budget deficit simply means is the government is going in there and borrowing money and using it rather than the private sector -- rather than consumers and businesses. So there is no direct link there.

"Now, there can be link if when the government does run big budget deficits, the Federal Reserve then on the other hand says, well, we have got to print more money. And that can spark higher inflation. This is called monetizing the debt.

"The good news is although that has happened in the past, it is actually fairly rare. And Fed Chairman Bernanke, for example, has signaled that he is not going to do that -- that he is not going to print extra money just to fund the higher budget deficits. So there could be a link there, but it is not a necessary link."

Posted by deeshore at January 21, 2010 08:14 AM