Do Goverment Deficits Cause Inflation? (Update and Bumped)

I would say most people who have an opinion believe they do.  It is the cornerstone of many arguments against government spending.  Unfortunately, data for or against this postulate is hard to come by, at least using the top couple hits on Google.  So I decided to do my own very rough study to get some idea of the correlation between government deficits and inflation.  Below is a graph of both going back to 1947 (the earliest I could find the deficit data).  I graphed the deficit as a percentage of GDP because it is only meaningful in relation to the size of the economy.

inflation-and-deficits
My personal statistician and fiancé ran the numbers not knowing the outcome I was looking for. She found a correlation of no more than 4% for the data using the same years and by lagging the inflation by up to 5 years. She tells me this is insignificant, meaning you could probably find this correlation by picking two random data sets with nothing in common. To be fair, if you look at the range from 1982 to 1994, there is a correlation of 39%, a moderate amount, but this is the best is gets, and it’s not the best idea to cherry-pick data like that.

Steve Conover, over at the Skeptical Optimist, has told me that real economists have tended to find no correlation and even negative correlation between inflation and deficits. He also published an interesting graphic showing that eras of debt pay down have been followed by recessions.

So, if it’s not deficits, what causes inflation? This is at least one whole post by itself, but the short answer is that printing money faster than economic growth causes inflation, period. Government deficits don’t cause inflation because deficits by themselves don’t create new money, they borrow it from the economy, so it’s effectively just moved around.

You can hate government spending for a lot of reasons, but inflation is not the best reason and it is not a good argument against spending. Unfortunately, that doesn’t mean it hasn’t been effective rhetoric.

Update: Steve Conover just did a similar post on the correlation of deficits and interest rates. It was slightly negative.

Sources
data360.org
Historical Inflation Data

(This was originally posted on April 15, 2009.)

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One Response to “Do Goverment Deficits Cause Inflation? (Update and Bumped)”

  1. Mark P Neyer Says:

    very interesting.

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