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Financing Government Deficits with Money

May 10, 2018 6 comments

In an earlier post, I described the budget constraint faced by the federal government. Here I want to point out how a deficit can lead to inflation. I will also indicate how the European Union (EU) and Greece are related to this discussion since there is an interesting difference between the U.S. and Greece regarding deficits and inflation.

Financing Deficits by the Central Bank

Suppose that the government has a deficit meaning that its spending for all purposes exceeds its tax revenue and that the government is unwilling to raise tax rates and/or cut spending. Now imagine that lenders will not lend to the government by buying the bonds that the government has tried to sell. In this situation, one financing option (bond sales to the public) for deficits is unavailable.  If nothing else is done to deal with the deficit, the government simply runs out of money and must shut down its operations until new tax money arises. But there is another option in the U.S. and many other countries; the central bank (the Federal Reserve in the U.S.) can buy the bonds sold by the government.

To see how this works, consider what the Fed can do. The government sells the bonds sold by the government and creates bank reserves as a result. Bank reserves would just be deposits at the Fed owned by banks. Those bank reserves will expand the money stock and so we have the Fed “printing” money to finance the government’s deficit. But to paraphrase the late Milton Friedman, inflation is a monetary phenomenon. Thus the government’s deficit can be accompanied by inflation. This appears to be happening now in the socialist paradise of Venezuela. But for Greece the situation is different because of its membership in the European Union (EU). Read more…

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Tax-Income Ratios in G7 Countries

September 13, 2017 Leave a comment

In a previous post, I provided data on the ratio of tax receipts to GDP in the U.S. It was shown that the U.S. ratio fluctuated around 20 percent of GDP since 1960. Here I provide data on the remaining G7 countries (Canada, France, Germany, Italy, Japan, and the United Kingdom) which illustrates how different the U.S. is from many European economies. Below is a graph of the data drawn from the OECD (the Organization for Economic Co-operation and Development) covering 1995 to 2015.

The graph shows that tax-income ratios are much higher in the six G7 countries than they are

in the U.S. In 1995, the tax shares ranged from a low of 27 percent in Japan to a high of 43 percent in France. By 2015,  the tax shares range from 32 percent in Japan to 48 percent in France. In short, none of the six countries has a tax share as low as the U.S.

The Entitlements Crisis

The aging of the U.S. population is increasing the transfer payments made by the U.S. government and the obvious question is how the U.S. will finance these payments. It is unlikely that this can be done by borrowing (it is doubtful that the U.S. can borrow trillions of dollars each year) so this suggests that the tax-income ratios in Europe are what may be imposed in the U.S. as the entitlements crisis unfolds. This is what is meant by the charge that many politicians want to turn the U.S. into a European welfare state. What remains to be seen is if the U.S. taxpayers will agree to such a historically large increase in the tax-income ratio in the U.S.

PIGS and the Eurobond

November 25, 2011 Leave a comment

The latest idea for dealing with the fiscal problems of the economies known as PIGS (Portugal, Italy, Greece, and Spain) is that bonds, backed by the entire Eurozone, be issued to finance government spending in the economies that are struggling to reduce their government deficits. One would think that the Germans would be opposed to this idea since the issuance of Eurobonds may result in the Germans paying for at least some of the spending by the PIGS.  However there seems to be some weakening in the German position as described in this article.

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