ABSTRACT

The model of monetary inflation derived in the previous chapters of this book makes no reference to either fiscal policy or fiat-money issued by the state. Yet throughout history budget deficits financed by central bank money creation have often been a cause of sustained inflation, and so it is desirable to explore whether the framework ofthis book is able to shed any insight into such episodes. Indeed, this chapter will show that there are a number of similarities between a government budget deficit financed by fiat-money creation and private sector investment expenditure financed by credit-money creation. Budget deficits have a similar multiplier impact on aggregate income and saving, for example, and the associated money flows can be represented in the familiar pattern of initial short-term finance that is subsequently repaid by the sale of long-term securities. If a government has access to central bank finance, however, there are also important differences. It may mean, for example, that the government is not subject to normal banking discipline concerning loan collateral and risk assessment, so that the initial finance may be used for consumption expenditure rather than capital formation. This has implications for the government's balance sheet and for the sustainable growth path of its public debt. Also, because government securities are normally accepted as an appropriate reserve asset for the banking system, rising levels of public debt are likely to facilitate the credit-money creation processes described in Chapter 3. This has implications for the central bank's task of maintaining price stability.