Living in a “swing” state, I am bombarded with political television ads. The GOP ads blame the 2021-2022 surge in inflation on Bidenomics and, by association, Harrisomics. A number of the elements of Bidenomics increased the federal budget deficit. But I will argue that federal budgetary deficits do not cause higher inflation. Rather, the actions of the Federal Reserve and the depository institution system cause higher sustained inflation rates by their combined ability to create credit figuratively out of thin air. The Federal Reserve and the depository institution system are, in effect, legal counterfeiters, i.e., they have the unique ability to create credit, figuratively, out of thin air. (Thin-air credit here will be defined as the sum of the Federal Reserve liability items, reserve deposits and vault cash of the depository institution system, currency held by the non-depository institution system, and the sum of depository institution system items, debt securities and loans. (An equivalent definition of thin-air credit is the monetary base, created by the Federal Reserve plus credit created by the depository institution system.) When credit is created out of thin air, the recipients of this credit are able to increase their spending without necessitating any other entity to reduce its spending. With some exceptions, when an entity other than the Fed/depository institution system lends to another, the lender reduces its current spending, transferring spending power to the borrower. This is called saving on the part of the lender.
Let us look at some data relating net federal borrowing as a percent of nominal GDP versus thin-air credit growth to goods/services price inflation. The inflation measure I will use in this analysis is the chain-price index for Gross Domestic Purchases. This inflation measure includes the prices of personal consumption expenditures, business expenditures, residential real estate services expenditures and government expenditures on goods/services. It excludes the prices of US goods/services exports. I have tested lead-lag relationships between net federal borrowing and inflation and thin-air credit growth and inflation. For both variables, the highest correlation coefficients occur when both net federal borrowing and thin-air credit growth lead inflation by two years. So, this year’s inflation rate is most highly correlated with net federal borrowing and/or thin-air credit growth two years prior.
If federal government net borrowing influences inflation, we would expect a negative correlation between the two series. And that is what we observe in Chart 1. The correlation coefficient between the two series is negative 0.14. Although the correlation coefficient has the correct sign, the absolute value of its magnitude, 0.14, is low, suggesting that there is not much association between the two series.