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Counter-Intuitive Inflation – How Overspending Creates Inflation

This is an excerpt from Counter-Intuitive Inflation. We’ll be posting sections over the first two weeks of October.

How Overspending Creates Inflation:

Right now, the US Congress is running a $2 trillion annual deficit. That’s the on-balance sheet number, and the one we see associated with the $33 trillion national debt. When you include off-balance sheet liabilities for programs like Social Security and Medicare, the actual annual deficit is closer to $8 trillion. What happens next is that between Congress, the Treasury, and the Federal Reserve, more debt is issued which effectively increases the supply of dollars. Very little of this spending results in the creation of valuable long-term infrastructure. Instead, it’s simply future consumption demand pulled forward.

This means that we have trillions of additional dollars chasing the same amount of goods. To make things worse, government programs often have the effect of incentivizing unproductive behavior meaning we end up with more dollars potentially chasing fewer goods. The result is inflation expressed as higher prices.

The original definition of inflation was an increase in the money supply. That definition has shifted over the years to mean an increase in prices. Either way, increasing the money supply leads to higher prices. So, while the definitions aren’t exactly the same, they are linked.

This kind of increase in the money supply was always going to lead to higher prices.

 

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