Deficit spending is printing banknotes

Deficit spending, also described as Government borrowing is equivalent to printing banknotes if it is inflationary

When the Government announces new spending, usually it is the "taxpayer" who we imagine to be losing out. This is the direct form of taxation, in contrast to inflation tax which targets those who hold fiat currency... But there are others ways in which the State can gain access to purchasing power that do not need to be recovered via taxation. They can print the money directly, in an obvious fashion and they can borrow. Government borrowing, also known as Deficit spending increases the money supply because Treasuries are treated as a store of value... and so borrowing is inflationary.

If it is not equivalent to "printing money" why then is it inflationary?

The Government "washes" treasury-money into the economy by exchanging it for other forms of money such as narrow money or bank credit. The act of selling the debt is symbolic but serves no economic function: The Government could just as well meet Government expenditure by paying Treasuries. They could pay the wages of civil servants with Government debt.

The (a) difference between Government debt and the debt issued by the banking system is that there is no-one to refuse the Government extra borrowing, they can continue for as long as they like. Private debt is subject to occasional contractions because some banks may refuse to lend. So, in this sense, Government debt is permanent whereas private debt is temporary. The Government will never (be able to) pay the money down... because it does not make a profit.


16th Jan 2009

Update: Bank loans are printing money

Bank lending increases the money supply because the deposits remain redeemable on demand... This is inflationary and affects the price of money which means it must be equivalent to printing money.

The fact that it is equivalent to printing money relies on the fact that bank deposits are guaranteed by the State and subsequently that Government liabilities would be met by printing money, rather than to default. Assuming new Government liabilities are inflationary, then new bank credit is inflationary since it creates new Government liabilities. If inflationary Government liabilities are equivalent to "printing money" then so too is bank credit. Unlike Government liabilities, bank credit may be un-printed when the debt is paid down: Government liabilities are rarely paid down since the Government almost never is in surplus. (17th Jan09)

Update2: Government yields are no measure of State (in)solvency

The value of Treasuries is derived from the likelihood that the debt will be monetised. Without the capacity to increase the money supply in this way, they (the Government) would be regarded as an insolvent entity.

There is no reason for someone with a printing press to default on their debt!

In the event that the Government do decide to default, this would be deflationary because it would mean that fewer banknotes are considered to be in circulation (discounting future money) now that expectations of printing are removed. Their price (Treasuries) would depend on an expected recovery rate and investors would consider themselves to be in possession of less currency.

Since the value of bank credit derives from a Government guarantee, such a default could alter the exchange rate between bank credit and legal tender as a consequence of doubts surrounding the State. Suddenly, both bank credit and (short-dated) Treasuries would be worth less relative to legal tender notes... (20th Jan09)

Update3: Unless you expect the Government to be able to pay back the debt with taxpayers cash...

...then deficit spending is the same as Quantitative Easing (which is the same as printing money...). (20th April'09)

Update4: The debt is not passed on to the next generation

Very often commentators and journalists will suggest that Government borrowing passes our problems on to the next generation. They do not realise that the inflation happens immediately and that the future generation will continue to keep borrowing. It is very likely that the previous generation made scornful comments at the Government of their day creating debts for our generation. Would they be surprised to see that we have chosen not to repay them, but instead issue further debt?

Because we have a fiat money supply, there is no upper limit on the amount that the Government can borrow.

The Government is creating debts for our children? Isn't that what they said a generation ago?

The Government will not be able to get the money (retrieve it) from the next generation of taxpayers... But the market already knows that. Treasuries still have value, though, because the money can be printed in any quantity since it is fiat... The value of Treasuries is not derived from the ability of the Government to repay its debts with revenue from future taxpayers, it is derived from the fact that the Government can repay its debts by printing money (monetising the debt)...

Government debt has no default risk because any amount of fiat currency can be printed on demand (they have their own printing presses). Which is why increased Government spending does not (significantly) affect Treasury yields... People like to be owed money by the group with the printing press. (22nd April'09)