FEDERAL BUDGET DEFICITS AND INFLATION
Deficits
The Biden administration is pushing big federal spending bills which may increase the federal budget deficit. The deficit for 2020 was already the largest since WWII: 14.9% of GDP compared to 13.9%, 29.6%, 22.2%, and 21% for the years 1942, 43, 44, and 45 respectively[1]. It is certainly the largest deficit since 1950, my usual starting point for analysis. And it is estimated to be larger for 2021. The history of the budget surpluses and deficits is shown in figure 1.
FIGURE 1
There are only 9 years of positive surpluses in the 71 year record (deficits are considered negative surpluses). The deficit got worse in every year of the last administration (2017 – 2020) although the final precipitous drop in 2020 was probably due in large part to the pandemic.
Now politicians, particularly Republicans, are trying to connect deficits to inflation, implying that larger deficits will cause higher inflation. It is almost certain that unrestrained printing of money led to the hyperinflation in The Weimar Republic (Germany) of the 1920’s, when people could not carry enough paper currency in a wheelbarrow to make ordinary purchases. But I was not certain that the borrowing required by larger deficits does the same, so I simply decided to look at the historical record for the U.S.
Inflation
Figure 2 shows the history of inflation over the last 71 years[2].
FIGURE 2
The Federal Reserve likes to keep the inflation rate close to 2% over the long run. Figure 2 indicates that they have been pretty successful at reaching that figure over the last 30 years, with all points between 0% and 4% since 1991.
Just looking figures 1 and 2, there doesn’t appear to be much correlation: that is, the curves don’t seem to move consistently in the same or opposite directions, even though I fully expected there to be a negative correlation between inflation rate and budget surplus (or, what is he same thing, a positive correlation between inflation rate and budget deficits). When I crunched the numbers, I was surprised. Figure 3 shows the result of the linear regression/correlation analysis.
FIGURE 3
The correlation coefficient, r = 0.08, is not statistically significant at the 0.05 level (actually a 25% chance that the two variables are unrelated or that the correlation is really zero). Worse yet the correlation is positive, not negative. That means higher inflation rates have generally accompanied higher surpluses or lower deficits. Even if we leave out the “plague year” of 2020, in which the budget deficit was huge but the inflation rate was still low (the far left point in Figure 3), there is still a positive correlation of r = 0.04. In this case there is a 37% chance the variables are unrelated, and of course the correlation is not statistically significant at the 0.05 level.
This result does not prove with certainty that big deficits don’t contribute to higher inflation. But it does prove with certainty that any such effect of deficits has been negligible compared to the effects of other factors on inflation over the last 7 decades.
Gary Waldman
September 2021
[1] Office of Management and Budget, www.whitehouse.gov/omb, Historical Table 1.3. Unfortunately the design of this website changes somewhat with each new administration. Now you can access the tables from the list in blue on the right side of the opening page. [2] U.S. Bureau of Labor Statistics. www.bls.gov series report CUSR0000SA0. All items in U.S. city average, all urban consumers, seasonally adjusted. I used the 12 month percentage change in the CPI each December.
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