Early on during the 2007–09 financial crisis, after the Fed committed to its unconventional asset purchase program (the first round of quantitative easing), several people — pundits and economists alike — predicted hyperinflation. For the most part, these predictions have been discredited: not only has there not been hyperinflation, but “core” inflation remains relatively low. My intention isn’t to again entertain the possibility of hyperinflation, but I’m interested in the answer to the following question: is hyperinflation meaningfully possible in the United States, and other economies with similar institutional qualities?
In This Time is Different, Reinhart and Rogoff use the term “graduation” frequently. What it refers to is the idea for an economy to “graduate” itself from certain classes of crises, or develop to a point where certain types of crises are no longer as likely to occur. For example, oft-repeated examples throughout the book are Spain and France, which “graduated” from debt crises after the 19th century (well, with regards to Spain, we’ll have to see if it relapses). They note that no country has “graduated” from financial crises. I wonder, though, if it’s possible to tentatively “graduate” from hyperinflationary episodes. Further, I wonder if the United States is an example of such graduation.
What brings me to this is some thought I’ve put into the question of the U.S. national debt, its projected size, the projected size of gross domestic product, and the degree of fiscal consolidation that the U.S. would ideally need to go through in order to guarantee some given “fiscal space” in case of a major financial crisis in the future. While I haven’t really done the work, including coming up with some numbers, it seems to me that sovereign default is becoming more probable over time. That is, unless the U.S. makes a habit of running surpluses during boom years, the government’s “fiscal space” will diminish over time, to the point that a major crisis may push the country’s finances over the edge, so to speak.
Putting that aside, and assuming its truth (for the sake of argument), which do you see as a more likely outcome?
- Technical default through inflation;
- Debt restructuring.
The reason I ask is because hyperinflation is associated more with (1) than with (2). Hyperinflations tend to occur in countries where government expenditure is mostly financed through the printing press, and these governments also tend to have issued large amounts of sovereign debt (that is, printing presses are resorted to when capital markets dry up). I’d say that (2) is associated more with monetary and output contractions, and the devaluation of safe assets (sovereign debt), which in turn can cause or exacerbate financial crises.
In the case of the United States, I’d think that (2) is the most likely route. First, there is a general culture which penalizes fiscal excesses and imputes on the mind the notion that spending through inflation is undesirable. Second, the Fed is independent, and is likely to remain independent (this can also feed on the first consideration). Fed independence implies a misalignment of intentions between politicians and those responsible for monetary policy. Third, there is always a large number of politicians, pundits, and ideologues who advocate fiscal conservatism, meaning that there is bound to be political support for debt restructuring over alternative forms of debt default. More generally, the United States has political institutions that rewards certain outcomes over others.
Given these institutions, can we make the claim that the U.S. has “graduated” hyperinflation? To be clear, graduation doesn’t imply that economies cannot devolve, or worsen in quality — there are, in fact, several examples throughout history of just this occurring. Further, it doesn’t imply that alternative forms of governance aren’t better. The question really is: have some countries, like the U.S., outgrown hyperinflation? I think there is a strong case to argue ‘yes.’
Tangentially, I don’t know the literature on hyperinflation very well, but to what degree does hyperinflation depend on expectations? Hyperinflation requires the expectation that the money supply will continue to grow at an accelerating pace, meaning that the issuer’s credibility is essentially nil. Is it possible for an independent Fed — or, at least one short of monetizing government debt and funding expenditures — to “achieve” such low levels of credibility? It’s difficult for me to think of a legitimate program, even within the range of the “unconventional” (such as large scale non-treasury asset purchases), that would result in infinitely elastic expectations. This is why when I talk about hyperinflation I consider political institutions, rather than monetary institutions in particular, most relevant.