The Problem With ‘Monetizing the Debt’

(via Getty Images)

“Inflation is always and everywhere a monetary phenomenon.” So said Milton Friedman, and so say his monetarist acolytes. If you ask a particularly reactionary kind of economist (my kind of economist!), he or she will tell you that what inflation actually means is an increase in the money supply, that what we usually mean when we say inflation—a general increase in prices—isn’t inflation at all, but only a consequence of inflation. Inflation, from that point of view, means inflating the money supply. You know—like this:

(via the Federal Reserve Bank of St. Louis)
(via the Federal Reserve Bank of St. Louis)

If you held the money supply constant while the economy grew, then you’d get deflation, or relative deflation, i.e., a money supply that is smaller relative to the size of the economy. In principle, there isn’t anything necessarily wrong with that: Deflation rewards savers (because the money they hold increases in value relative to goods and services) and punishes borrowers (who have to pay off yesterday’s debts in today’s more valuable dollars), while inflation penalizes savers (because the money they hold decreases in value) and rewards debtors (who get to pay off yesterday’s debts in today’s less valuable dollars). There’s just the question (again, in theory) of whose ox is getting gored, of who is getting subsidized and who is in effect getting taxed by monetary policy. In reality, experience suggests that deflation has significant undesirable economic effects, the general idea being that as real prices fall, households and firms are likely to put off purchases—why pay $100 today for something that will be $90 in a week?leading to reduced economic activity, driving real prices down even farther—the dreaded “deflationary spiral.” That’s the conventional, widely held understanding of the situation, though there are dissenters. As the Polish economist and politician Jacek Rostowski wrote 20 years ago in the New York Times:

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