econintersect.com
       
  

FREE NEWSLETTER: Econintersect sends a nightly newsletter highlighting news events of the day, and providing a summary of new articles posted on the website. Econintersect will not sell or pass your email address to others per our privacy policy. You can cancel this subscription at any time by selecting the unsubscribing link in the footer of each email.



posted on 22 May 2016

How Does Government Spending Affect Inflation?

from the St Louis Fed

-- this post authored by William Dupor, Assistant Vice President

Lackluster U.S. gross domestic product (GDP) growth may lead to renewed calls for new government spending to stimulate the economy. [1] One possible justification is that an increase in government purchases might drive up the cost of production. In turn, this would drive up inflation. So long as the Federal Reserve does not counteract this increase with restrictive monetary policy, the increase in inflation might drive down the real interest rate. [2] A lower cost of borrowing might drive up households' consumption and businesses' investment in equipment and structures.

This is an interesting theoretical mechanism by which government spending stimulus might increase output indirectly though inflation. Whether this channel works empirically is another question. It also goes to the broader question of how inflation is affected by fiscal policy.

Words from Milton Friedman

In a debate from nearly 50 years ago, economist Milton Friedman characterized the then-current state of economists' understanding about fiscal policies' effect on inflation: "Surely, I think the time has come to utter the usual poker challenge to those who maintain that fiscal effects are important for inflation and the price level. It seems to me that it is time they put up and give us some evidence to support the repeated assertions to that effect." [3]

Until recently, Friedman's quote has remained pretty accurate. Why have economists had little to say empirically about the effect of government spending on inflation? I studied this question in a recently published paper co-authored with Rong Li of Renmin University of China.[4]

There are two high hurdles to answering this question that only a few papers have been able to overcome:

  • Finding episodes in which one can be confident that the central bank is not working to offset the potentially inflationary effects of fiscal policy

  • Experiencing exogenous changes in government spending over time to construct so-called natural experiments to assess the spending's effect on inflation

We overcame the first hurdle by looking at the U.S. between 1959 and 1979, when the Fed followed a policy in which it accommodated increases in inflation. We overcame the second challenge by using a host of procedures economists have previously used to isolate exogenous changes in government spending.[5]

Little to No Effect on Inflation

Across the board, we found almost no effect of government spending on inflation. For example, in our benchmark specification, we found that a 10 percent increase in government spending led to an 8 basis point decline in inflation. Moreover, the effect is not statistically different from zero.

Does our finding, by itself, imply that countercyclical government spending is ineffective at boosting output? Not necessarily. Our paper simply demonstrates that the inflation channel of government spending is not an empirically important way that this spending might affect the economy.

Notes and References

1 Real GDP growth for the first quarter of 2016 was 0.5 percent at a seasonally adjusted annual rate.

2 One reason that a central bank might not counteract the potentially inflationary effect of government spending is that the nominal interest rate might already be stuck at the zero lower bound. Even if the central bank were not stuck at the zero lower bound, it might choose to not pursue a contractionary monetary policy because it recognized that the economy was in a recession.

3 Friedman, Milton; and Heller, Walter. "Monetary vs. Fiscal Policy: A Dialogue," New York: Norton, 1969.

4 Dupor, William; and Li, Rong. "The Expected Inflation Channel of Government Spending in the Postwar U.S.," European Economic Review, 2015, Vol. 74, pp. 36-56.

5 These include, for example, using variables related to new military spending, such as stock returns on defense industry firms.

Source

https://www.stlouisfed.org/on-the-economy/2016/may/how-does-government-spending-affect-inflation

Additional Resources

>>>>> Scroll down to view and make comments <<<<<<

Click here for Historical News Post Listing










Make a Comment

Econintersect wants your comments, data and opinion on the articles posted.  As the internet is a "war zone" of trolls, hackers and spammers - Econintersect must balance its defences against ease of commenting.  We have joined with Livefyre to manage our comment streams.

To comment, using Livefyre just click the "Sign In" button at the top-left corner of the comment box below. You can create a commenting account using your favorite social network such as Twitter, Facebook, Google+, LinkedIn or Open ID - or open a Livefyre account using your email address.



You can also comment using Facebook directly using he comment block below.





Econintersect Contributors


search_box

Print this page or create a PDF file of this page
Print Friendly and PDF


The growing use of ad blocking software is creating a shortfall in covering our fixed expenses. Please consider a donation to Econintersect to allow continuing output of quality and balanced financial and economic news and analysis.


Take a look at what is going on inside of Econintersect.com
Main Home
Analysis Blog
The Theory of the Monetary Circuit: A Critique
The Expected Effects of Petitions to Improve the Monetary System
News Blog
This Mushroom Starts Killing You Before You Even Realize It
August 2016 Median Household Income Has Declined From The Beginning Of The Year
August 2016 Pending Home Sales Index Declines?
24 September 2016 Initial Unemployment Claims: Rolling Averages Continue to Improve.
Third Estimate 2Q2016 GDP Revised Upward. Corporate Profits Down.
The Terrorist Networks At Our Fingertips
Infographic Of The Day: Dubai Interesting Statistics And Facts
Early Headlines: Asia Stocks Up, Oil Surges, OPEC Cuts Production, Student Loan Woes Mount, Trump Still Close, Aleppo Hospitals Bombed, Huge Wind Storm In Oz And More
The World's Most Sustainable Cities
Big Sam In Bad Company
Other Ways To Spend Your AirPod Budget
Crashing Space Station Shows Why China Must Start To Collaborate In Orbit
NFL Edges Towards A Full House In London
Investing Blog
Will Deutsche Bank Survive?
Banks Of Absurdity
Opinion Blog
The Federal Reserve Note
Trump, Trade And Taxes
Precious Metals Blog
War On Cash Turns To $20, $50, And $100 Bills
Live Markets
29Sep2016 Market Update: WTI Crude Rises Into 48 Handle, Goldman Sticks To Lower Crude Prices In The Future, US Dollar Volatile Reflecting On Future Market Movements, Gold Moving Higher Signaling Weakening US Market
Amazon Books & More






.... and keep up with economic news using our dynamic economic newspapers with the largest international coverage on the internet
Asia / Pacific
Europe
Middle East / Africa
Americas
USA Government



Crowdfunding ....






























 navigate econintersect.com

Blogs

Analysis Blog
News Blog
Investing Blog
Opinion Blog
Precious Metals Blog
Markets Blog
Video of the Day
Weather

Newspapers

Asia / Pacific
Europe
Middle East / Africa
Americas
USA Government
     

RSS Feeds / Social Media

Combined Econintersect Feed
Google+
Facebook
Twitter
Digg

Free Newsletter

Marketplace - Books & More

Economic Forecast

Content Contribution

Contact

About

  Top Economics Site

Investing.com Contributor TalkMarkets Contributor Finance Blogs Free PageRank Checker Active Search Results Google+

This Web Page by Steven Hansen ---- Copyright 2010 - 2016 Econintersect LLC - all rights reserved