Analysis Ties Surge in Inflation to Increased Spending, Value of Debt
Fred Lucas /
The U.S. government and those of other countries could be using higher inflation to lessen the value of growing public debt resulting from increased spending during the COVID-19 pandemic, according to a new analysis by a Harvard economist working with The Heritage Foundation.
The study covers government spending from 2020 through 2022, the high point of the pandemic, and looked at the U.S. and 20 other economies in the Organization for Economic Cooperation and Development, or OECD.
Robert Barro, a distinguished fellow in economic thought at The Heritage Foundation who also is the Paul M. Warburg professor of economics at Harvard University, spoke about his research Thursday at an event at the leading think tank called “Inflation: Today’s Financial Pandemic.” (The Heritage Foundation is the parent organization of The Daily Signal.)
“What are the policy implications? It’s very clearly supported from these kinds of results that the inflation in the U.S. and these other major economies did reflect very strongly on the fiscal surge, which was generated in particular as a response to the COVID crisis,” Barro said during the Heritage event. “It succeeds in demonstrating clearly a strong linkage between the fiscal outlay and the resulting inflation.”
Under the framework in the study, Barro said, more spending triggers more inflation. The higher initial public debt and longer duration for the debt mean lower inflation.
“You can think about the inflation surge as partly a way to pay for the fiscal effort,” the economist said. “In the context of an emergency like World War II or the COVID emergency, it may not be crazy to do that. It can be relatively efficient to have this kind of contingent response to a fiscal outlay that is related to some kind of crisis—again wartime being the classic example.”
Barro’s remarks came on the same day the Labor Department reported that the consumer price index, a key measure of inflation, increased in December by more than most economists projected. The CPI was up 0.3%, higher than the predicted 0.2%. Year over year, it was up 3.4%, compared with the projected 3.2%.
Wages adjusted by 0.2% from November, or 0.8% from a year earlier. The bulk of that increase was because of shelter or housing costs, which went up by 0.5%, or 6.2% year to year.
Food prices went up by 0.2% in both November and December. Energy increased 0.4% in December, although it fell by 2.3% in November.
Barro contended that the increase in inflation might not be as simple as presuming that government officials, including those at the Federal Reserve, didn’t know what they were doing.
“So it may not be so simple as that this inflation was really stupid,” he said. “There may actually be a rationale for having this kind of response. And again, not just in the U.S., but more broadly, across this group of [21] countries.”
Inflation could work only in emergencies as a strategy for addressing the size of public debt, Barro said, because it amounts to “partial default on the public debt.”
But, he said, countries can benefit by deflating the real value of debt through inflation.
“That is the way this thing, in terms of how much public debt is out there, how that interacts with inflation,” he said during a question-and-answer session. “It’s creating this incentive effectively for the monetary authority to inflate, and implicitly they are cooperating.”
“Now, I should say I think the close linkage between the fiscal situation and the monetary and inflation situation is not something that typically applies,” Barro said. “It’s something that applies here in this emergency context, like in wartime, COVID crisis. And that’s when you get this kind of big surge.”
“If you look at normal times—quote, normal—but at least not this extreme emergency, you don’t see this close connection between the fiscal situation and the monetary inflation situation,” he said.
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