Inflation is caused when debts are made that will not be paid back

...providing we expect that the lender will be compensated for non-repayment of debt, which can only be with new money

Why don't taxpayers (usually) act in a more frugal manner in response to Government borrowing? It is because they do not think the debts will be repaid with money taken from them. They think the money will come from somewhere else, and since it is known that currency is no longer backed by a fixed commodity there is no reason (other than distaste) that the money should not be printed...

When the Government borrows money, the person lending has less money to spend but the Government feels free to spend the money even thought they have this new (debt) obligation... This is true also for personal debts outside the banking system: Unless we expect that the debt will not be paid back (and it is not true that they prefer being in debt to one person over the other, in which case this is not like-for-like debt and a gift has been given in the form of less vengeful creditors) there is no reason for the borrower to consider themselves to be in a better position to spend the money.

Lending outside the banking system does not cause inflation because, whereas the debts might not be paid back this will result in (permanently) less purchasing power for the lender since they will not be compensated.


If money is loaned that is unlikely to be paid back, this causes inflation when the lender does not feel troubled that the person being loaned money is not credit-worthy. If you aren't concerned that your money has been loaned to a person not able to pay you back this means that you expect to be compensated by another source.

Government borrowing causes inflation because the lender (the bond-holders) still think that they are going to get their money back (which, if it is monetised, they will do so) even though the borrower is shoddy, fickle and indolent*. When the lender realises that they are not going to get their money back, in the event of a failure to print the required money... this is when we see a deflation of prices as Government securities lose their value.

Government borrowing causes inflation because the lenders think they are going to get their money back and (even though) the Government is not a reliable borrower, without (unless they are able to) resorting to the printing presses.

The same is true of the banking sector; deposit-holders still think that their money is reliable even though it has been loaned out to someone else... Regardless of whether they trust the borrower, (even if they do trust them) they still do not suffer the (temporary) lack of purchasing power which would typically result from money being loaned out. This may be because either they are ignorant of the process or they trust the Government guarantee (of bank deposits). Because deposit-holders (and everyone else) treat bank deposits as though they have value, lending of this kind causes inflation.


It will be deflationary when people with money think that the Government will take their cash from them to repay the Government debt... should they ever have cause to think that.


*But then, are they really all of these things, or instead acting out of (perceived) self-interest within the environment... At least they know that the lender will not be out of pocket, except for inflation of prices.

Monday 27 April 2009