60 Finance & economics The Economist December 18th 2021
Of Miltonandmoney
H
ere is apotted history of recent economic policy and infla
tion. In the 2010s central banks created vast amounts of mon
ey through their quantitativeeasing (qe) schemes, while govern
ments enacted fiscal austerity. Inflation in the rich world was
mostly too low, undershooting central banks’ targets. Then the
pandemic struck. There was plenty more qe. But the truly novel
economic policy was the $10.8trn in fiscal stimulus implemented
worldwide, equivalent to 10% of global gdp. The result was high
inflation. The rich country that has splurged the most, America,
has had the most inflation. With consumer prices rising at an an
nual pace of 6.8%, the Federal Reserve on December 15th was
forced to acknowledge that inflation had become a big threat.
At first glance, this apparent supremacy of fiscal policy is awk
ward for fans of Milton Friedman’s view that inflation is “always
and everywhere a monetary phenomenon”. Central banks, not
governments, are charged with hitting inflation targets. But does
the experience of the pandemic show that inflation is really fiscal?
One way in which fiscal stimulus boosts inflation is by
strengthening households’ and firms’ balancesheets, making
them more likely to spend. Suppose the government raises cash
from investors, who receive bonds in exchange. Then it hands out
the money to households, returning it into circulation. Netting
off, it is as if the government has just given out new bonds. Wheth
er those bonds truly constitute new wealth for the private sector is
the subject of an old theoretical debate. When the government
runs up debts the public could also expect to pay higher taxes in
the future—a liability that offsets their newly created assets. Yet in
reality it is clear that fiscal stimulus leads to more spending.
Now introduce a new step into the thought experiment. The
central bank, implementing qe, creates new money with which it
buys the bonds that the government has given out. So when you
net everything off, the government is not giving out bonds. It is
giving out cash. This is not far off the policy mix during the pan
demic. The tsunami of fiscal stimulus was accompanied by bond
buying of almost equal magnitude: central banks in America, Brit
ain, the euro zone and Japan have together bought more than
$9trn in assets. The result has been a surge in deposits at commer
cial banks. In America they have risen from around $13.5trn in early 2020 to around $18trn today. As early as the spring of 2020 some
monetarist economists, such as Tim Congdon of the University of
Buckingham, pointed to surging measures of broad money, which
includes bank deposits, and warned of inflation to follow.
So far, so Friedmanite. But which leg of the policy matters
more: the fiscal stimulus, which boosted aggregate household
wealth, or qe, which ensured the infusion was of cash and not of
bonds? There is probably something special about infusing
households’ balancesheets with cash, says Chris Marsh of Exante
Data, a research firm. He has suggested that a “rediscovery” of mo
netarism could be in the offing after the pandemic.
Other economists, however, argue that qeis mostly ineffective,
except in periods of acute financial stress, such as the “dash for
cash” in spring 2020. Suppose that once that crisis had passed cen
tral banks had shrunk their balancesheets quickly, but had still
promised to keep interest rates at zero for a long time. It seems
likely that America’s enormous fiscal stimulus would, by boosting
household wealth, still have driven up spending and prices.
Yet believing in the impotence of qecompared with fiscal stim
ulus is in fact consistent with monetarism—if you expand the de
finition of money. Distinguishing the electronic money created by
central banks from debt securities issued by governments is
increasingly difficult. This is partly because when interest rates
are close to zero, they are closer substitutes. It is also because most
central banks now pay interest on the electronic money they
create. Even if rates were to rise, socalled “interest on reserves”
would still leave electronic money looking a bit like public debt.
The reverse is also true. Investors value government debt, espe
cially America’s, for its liquidity, meaning they are willing to hold
it at a lower interest rate than other investments—much like the
public is willing to accept a low yield on bank deposits. As a result
“it seems more accurate to view the national debt less as a form of
debt and more as a form of money in circulation,” wrote David An
dolfatto of the Federal Reserve Bank of St Louis in December 2020.
He also warned Americans to “prepare themselves for a temporary
burst of inflation” in light of the oneoff increase in national debt
during the pandemic. If money and debt are substitutes, just
swapping one for another, as qedoes, might provide little stimu
lus, consistent with the experience of the 2010s. But expanding
their combined supply can be powerfully inflationary. Right on the money
The logical extreme of this argument is known as the “fiscal theory
of the price level”, created in the early 1990s (and in the process of
being refreshed: John Cochrane of Stanford University has written
a 637page book on the subject). This says that the outstanding
stock of government money and debt is a bit like theshares of a
company. Its value—ie, how much it can buy—adjusts to reflect
future fiscal policy. Should the government be insufficiently com
mitted to running surpluses to repay its debts, the public will be
like shareholders expecting a dilution. The result is inflation.
Explaining today’s high inflation does not require you to go
that far, though. It is enough to look at recent deficits, rather than
to peer into the future. Yet it is striking that economists like Mr
Andolfatto who focused on the supply of government liabilities
foresaw today’s predicament while most central bankers, whose
eyes were fixed firmly on labour markets as a gauge of inflationary
pressure, did not. The past decade hasshown that when interest
rates fall to zero, it takes more than justqeto escape a lowinfla
tion world. Still, Friedmanism lives on.nFree exchange
Has the pandemic shown inflation to be a fiscal phenomenon?