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Opinion

Coronavirus stimulus inflation risk depends on politics, not economics

Despite massive programs, Japan and the US will not see hyperinflation

| Japan
It is not the overspending or the deficits per se which provoke the currency runs.   © Reuters

Adam Posen is President of the Peterson Institute for International Economics in Washington, DC.

Japanese economists would recognize the repeated questions about inflation risks from the apparent monetization of government debt underway in the U.S. and Europe. Where is the inflation given all the money printing?

I am much less worried about the inflation risks than many others are. I have thought about this topic often through the years, starting with my research on Japan in the 1990s, and my first speech as a member of the Bank of England monetary policy committee, back in October 2009.

Recent developments have caused me to consider this issue once again, and again conclude that mechanistic monetarism is misleading. Yes, if the central bank finances government deficits, and those government deficits are large and accumulating, inflation and potentially hyperinflation could result.

Inflation, however, comes through two channels primarily: one, too much nominal demand chasing a far more slowly growing actual supply of goods and services; two, capital flight from the economy -- or from assets denominated in the government's currency -- driving down the purchasing power of the currency in real global terms. These two channels can coincide and reinforce each other, but need not occur simultaneously.

In a modern economy, most of the demand is not in the form of cash, but in the form of credit of various kinds. So, there are two additional steps needed to get from debt monetization to (hyper)inflation. The money printing must translate into credit growth in the economy; and the credit growth must translate into effective nominal demand.

On the currency side, there are more factors at play, but again at least two additional steps are needed to reach (hyper)inflation. People must overcome their bias toward holding domestic assets, which varies according to country and period, e.g. 1980s Argentina against 2000s Japan.

People also must believe that there is something else out there which is more attractive or at least less dangerous than the domestically denominated government assets, net of transaction and monitoring costs. Additionally, there has to be a mechanism around the soft or harder constraints on capital outflow which some governments erect.

Therefore, the creation of money to purchase government bonds will not translate into inflation unless there is also sufficient nominal demand to meaningfully outstrip the growth in real GDP or sufficient relative incentive for capital to leave. In the current economic environment of low wage pressures, low real rates, high cross-border economic conflict and high risk-aversion, seen in flight to safety, you cannot "get there from here" in the rich countries.

Admittedly, there is some circularity to this position, or what economists call a multiple-equilibrium possibility. If enough people decide that a government/currency are not trustworthy, it can become self-fulfilling through savers trying to shift investments out of local currency into real or foreign assets. The historical evidence of the last 200-plus years, however shows that wealthy democracies are not subject to this risk.

What shifts a society from being in the column of present-day Japan or the U.S. to being in the column with Argentina of the 1980s or Weimar Germany of the 1920s with respect to inflation vulnerability?

The main factor seems to be social division and breakdown of government ability to make decisions. It is not the overspending or the deficits per se which provoke the currency runs and (hyper)inflation. Rather, it is the emergence of disbelief that the government will pay its bills by ultimately raising taxes or cutting spending enough. A variant of this distrust of future government action is the belief that your class or ethnic group or region will be expropriated when other groups will not.

It is not a numerical financial calculation of what is or is not sustainable debt, because what is sustainable -- for rich countries with domestic currency financing of debt -- depends upon how much faith people have in the taxation power of the government. This is why Italy or Greece got into trouble in a way that other Europeans did not a decade ago, even though some other countries had similar debt levels.

The ability of the U.S. Congress and administration to get past deadlock for passage of the current fiscal support programs makes me hopeful that the U.S. is not there yet, as does the new agreement on some joint spending and borrowing for the EU. But watch the politics not the numbers for inflation risk.

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