From QE to Queasy: Fiscal Policy and the Risk of Inflation
February 7, 2013
by Jason Hsu
of Research Affiliates
As the Federal Reserve persists in its quantitative easing (QE) program and the U.S. Congress temporizes over the debt ceiling, it seems worthwhile to revisit the macroeconomic links between monetary policy, fiscal policy, and inflation. Writing as a macroeconomist who favors the fiscal theory of inflation, I will argue that QE, by itself, largely does not change the public or private sector balance sheets.[i] What QE accomplishes is, rather, to enable more unchecked governmental spending on potentially unproductive (negative net present value) projects. This fiscal channel, which significantly deteriorates the government’s balance sheet through debt-financed public spending, then drives inflation, as excess spending is met by slowed production. Thus far, the spending financed by QE has not resulted in material inflation, but the conditions are clearly in place.
Moreover, to exacerbate the danger, in response to the massive deficit spending—which is dominated by welfare transfers from future taxpayers to the current generation—U.S. households are more likely to consume with abandon (and entitlement) instead of investing for the future. I offer a pessimistic prognosis that Americans will choose to imitate the southern Europeans, not the Japanese, in their response to the irresponsible policies pursued by their politicians. In this scenario, inflationary pressure would only be magnified.
© Research Affiliates