The new large spending bill, known in the media as Build Back Better, was passed by the House recently. Opponents of the law are on record saying that passing a large spending bill right now will somehow hurt struggling Americans. The opponents insinuate that a large spending bill will make inflation, which is reportedly at a “thirty year high,” even worse. Defenders of the bill respond by saying that the bill will not exacerbate inflation because it is “paid for.” Both sides can’t be correct. Even if the future is unpredictable, we can judge who has a better argument.
The opponents of the bill aren’t providing much of an argument here. They instead appeal to popular prejudices, which may have at least a grain of truth in them. I think all economists would agree that Y = C + I + G, etc. and that the G stands for government spending. If G is increased while all of the other variables are constant, then total spending will increase. I think also that economists would agree that “when prices are rising, it is because Demand is outpacing Supply” (Robert L. Heilbroner & Peter L. Bernstein, A Primer on Government Spending, New York: Vintage Books, 69). Even if we just focus on the Demand side, it’s an open question whether increasing G, government expenditures, will be done without bringing I, investment, or C, consumer expenditures, down. Recall the rebuttal from the supporters of the spending bill. They say that it’s “paid for.” Sometimes, the defenders will admit that the bill raises taxes. (For the bill to be paid for, it would also have to raise revenue. There is, however, not always a positive relationship between tax rates and revenue.) We don’t expect tax increases to be popular among those who will be paying the taxes; so it’s understandable if proponents of a bill won’t be going out of their way to mention them. In the case of a trillion dollar bill in 2021, those arguing for it have no choice but to persuade the public that the bill will not be inflationary. If taxes are raised, it’s safe to say that someone is going to have less money to spend. In our equation Y = C + I + G, Y is income or expenditures. G can rise because of increased taxes, but Y won’t necessarily rise because I, C, or both will be reduced. Perhaps I am making too many simplifying assumptions. The real world is, of course, complex. If a bill, however, is really “paid for,” then it means that, in the static model at least, Y or Demand is not going to increase.
The rebuttal from the supporters of the bill is, therefore, a good one, economically speaking. If the bill is indeed “paid for” and if the critic concedes as much, then his talking point about inflation isn’t even superficially plausible. Perhaps, the huge price tag of the spending bill should be alarming, but we can’t say that its size must lead to inflation. The conclusion doesn’t follow from the premise. Senator Bill Cassidy knows better than to concede that the bill will be financed solely with tax revenues. He said, “[I]f you are going to avoid inflation, then you’ve got to be able to pay for [the bill]” (This Week, 28 November 2021). Cassidy apparently thinks that the revenue will fall short of the expenditures. Government will have to borrow the difference. The bill therefore will make it more likely that the government budget will be in deficit. Cassidy, however, is assuming that the government will not be able to borrow all of the money from private citizens. Technically, Cassidy’s statement isn’t completely accurate. As two economists explained,
[D]oesn’t deficit financing lead to an increase in the money supply, and isn’t that especially inflationary?...
If the government finances its deficit by selling securities directly to the public, the money that comes into the government is simply taken out of other people’s checking accounts, and therefore has no effect on the total supply of money. But when commercial banks buy the government’s obligations, then the money going into the government’s bank account is brand-new money, never withdrawn from any other checking account. This is what is meant by “monetizing” the debt.
Therefore, this curiously magical bank-financed deficit can indeed be inflationary. (Heilbroner & Bernstein, A Primer on Government Spending, 73 & 74)
Although unstated, Cassidy’s assumption about debt “monetization” has been around for a long time. Nearly sixty years ago, a Congressman said, “With governments, continued deficit spending inevitably leads to debasement of the currency” (quoted in Ibid, 13). They key word here is deficit. Government spending per se is not inflationary, and it need not increase total demand.
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